Bank of Canada Keeps Rates On Hold As It "Looks Through War's Immediate Impact On Inflation"

As expected, the Bank of Canada - which was the day's first G5 central bank to hit the tape ahead of the Fed's decision at 2pm ET - held interest rates unchanged at 2.25% as expected, saying adjustments to borrowing costs would likely be small if the economy and inflation evolve as expected, while stating that it is looking through the war's immediate impact on inflation but will not let higher energy prices become persistent inflation.

“A policy rate close to current settings looks appropriate to support adjustment in the economy and return inflation to target,” BOC Governor Tif Macklem said adding that “There may still be a need to adjust the policy rate depending on how the risks evolve. But if the economy evolves broadly in line with the base case, changes in the policy rate can expected to be small."

At the same time, officials flagged major risks to their outlook, including a review of the North American trade deal, the conflict in the Middle East and ongoing damage from the impacts of US tariffs, which could all require different responses for monetary policy.

Macklem explicitly outlined how officials may have to adjust borrowing costs more significantly in some scenarios. He noted that while additional US trade restrictions could prompt cuts to the policy rate, rising and persistently elevated energy prices would lead to tightening.

“If oil prices continue to increase, and particularly if they remain elevated, the risk that higher energy prices become generalized inflation increases,” Macklem said. “If this starts to happen, monetary policy will have more work to do — there may be a need for consecutive increases in the policy rate.”

Macklem said Canada is being buffeted by global events and geopolitical uncertainties, higher global energy prices are pushing inflation up, and monetary policy is focused on ensuring jump in energy prices does not turn into persistent inflation

The governor said the BOC has three key messages:

1. Canada is being buffeted by global events and geopolitical uncertainties, but our economy is growing and is expected to continue to grow.
2. After more than a year with inflation close to the 2% target, higher global energy prices are pushing inflation up. The surge in gasoline prices combined with still-elevated food price inflation is squeezing more Canadians.
3. Monetary policy is focused on ensuring the jump in energy prices does not turn into persistent inflation, while helping the economy adjust to global headwinds. We are committed to keeping inflation low and stable overtime.

Middle East

• Since previous forecast in January, the war in the Middle East has sent global energy prices sharply higher, increased financial market volatility and disrupted shipping for fertilizer and other commodities. This has lowered the outlook for global growth while boosting inflation.

Growth 

• Growth looks to have resumed after contracting at the end of 2025. Consumer and government spending are contributing to growth, while US tariffs and trade uncertainty are weighing on exports and business investment.
• The conflict in the Middle East will affect the composition of growth, but the impact on overall growth is expected to be small because higher global oil prices increase the value of our energy exports even as they squeeze consumers and many businesses.

Policy

• Our baseline forecast assumes oil prices will come down and US tariffs will remain at the current levels. If this holds true, a policy rate close to current settings looks appropriate to support adjustment in the economy and return inflation to target.
• There may still be a need to adjust the policy rate depending on how the risks evolve. But if the economy evolves broadly in line with the base case, changes in the policy rate can be expected to be small.
• However, uncertainty is unusually elevated, and there are many possible outcomes. Monetary policy may need to be nimble.

Outlook

• We are closely monitoring the impact of the conflict in the Middle East and how the economy is responding to US tariffs and trade policy uncertainty.
• Governing Council is looking through the war's immediate impact on inflation but will not let higher energy prices become persistent inflation.
• As the outlook evolves, we stand ready to respond as needed.
• The Bank is committed to maintaining Canadians’ confidence in price stability through this period of global upheaval.

“While the war in Iran may alter its composition, overall GDP growth is little changed in the updated forecast,” the bank said. “Since Canada is a large net exporter of oil, higher oil prices increase national income even as consumers are squeezed by higher gasoline prices.” Previously, the bank said it could not predict the length and scale of the Iran conflict, calling the economic impact “highly uncertain.”

The monetary policy report notes that its projections for inflation and growth are highly conditional on the assumption that US tariffs remain unchanged and that oil prices gradually decline to $75 per barrel by mid-2027.

Both the Iran war and US trade policy pose both upside and downside risks to inflation, the bank said. While a prolonged conflict in Middle East could stoke inflation further, it could also have a more negative impact on global growth.

The bank also warned that businesses could face more costs adjusting to US tariffs, which would risk fueling inflation. But tariffs could also weigh on demand by more than expected and a review of the US-Mexico-Canada Agreement scheduled for July 1 could yield an outcome that is worse than assumed, dragging on growth and inflation.

The bank left its estimate of the neutral rate — the level of borrowing costs that neither restrict nor stimulate economic growth — between 2.25% and 3.25%.

In kneejerk reaction,the USDCAD rose from 1.3692 to 1.3710 as the BOC acknowledged that it will look through the war's immediate impact on inflation.