Iran war, U.S. trade policies remain key worries for Bank of Canada in setting rates

The Bank of Canada’s governing council kept the key overnight rate unchanged at 2.25% for the fourth meeting in a row, as geopolitical risks and trade tensions weigh on economic projections. Deliberations highlighted concerns about soaring oil prices linked to the Iran war and the potential impact of U.S. tariffs on Canada’s economic stability. Members anticipate inflation will peak at 3% in April 2026 before gradually declining to the 2% target by early 2027, assuming oil prices ease and U.S. tariffs remain unchanged. Gross domestic product (GDP) growth is projected at 1.2% for 2026, rising to 1.6% in 2027 and 1.7% in 2028, driven by stronger exports and business investments. However, this outlook is conditional on lower oil prices and no additional U.S. trade restrictions. If energy prices remain high, inflation could stay elevated longer, possibly requiring further rate hikes. Conversely, new U.S. tariffs could weaken economic activity and push inflation down, necessitating rate cuts. The council noted that core inflation showed signs of easing, despite March’s 2.4% headline rate driven by higher oil prices. Excess supply in the economy—where production outpaces demand—has kept inflation near the 2% target since mid-2024, reducing pressure on businesses to raise consumer prices. Businesses report stronger sales growth expectations and improving investment sentiment, though rising costs from geopolitical tensions, particularly the Iran war, remain a concern. Uncertainty surrounding the Canadian-U.S.-Mexico Agreement (CUSMA) negotiations adds to the risks, though businesses remain cautiously optimistic. The council acknowledged that excess supply could shrink faster than expected, allowing businesses to pass on higher costs more quickly, especially if consumers become more price-sensitive. Supply bottlenecks and elevated energy prices could also broaden cost pressures across the economy, complicating the inflation outlook.