There may be a perfect storm on the horizon, and it’s leaving Canada’s central bank paralyzed. The Bank of Canada (BoC) held its key interest rate at 2.25%, a widely expected move. They warn that the economy faces slow growth and rising inflation—conditions that resemble a stagflation-like threat.
BoC Holds Rates On Stagflation-Like Conditions Surfacing
The BoC held its key interest rate at 2.25%, a level it has held for roughly 8 months and less than half of the 5.0% peak in 2023. Unfortunately, the lack of movement isn’t due to a Goldilocks economy where things are just right. It’s more like things are running too hot and too cold at the same time.
“Economic weakness combined with rising inflation is a dilemma for monetary policy,” said BoC Governor Tiff Macklem in this morning’s opening statement. “For now, holding the policy rate unchanged balances those risks.”
Stagflation is when an economy simultaneously faces rising inflation, stalling GDP, and elevated unemployment. No central banker will drop the S-bomb in public, but these are the conditions the BoC fears are materializing.
Canada’s Economy Is Stalling: Lower GDP, Elevated Unemployment
The central bank cited the mountain of weak economic indicators recently. GDP slipped 0.1% in Q1, housing activity is stalling, and employment has been “little changed since the start of the year,” notes the BoC’s decision.
Consumer spending rose 1.4%, but that wasn’t enough to offset weakness in housing, business investment, and broader economic growth.
There’s little doubt here—the economy is slowing in a way that’s hard to ignore. Normally, slower consumption and an economy that could use a jolt would present the need for rate cuts. The path to cheaper credit isn’t as clear this time.
Bank of Canada Sees Inflation Running Hot In The Near-Term
Annual growth of CPI inflation hit 2.8% in April, about 40% faster than the central bank’s target rate. They expect CPI to hover around 3% in the coming months, though oil prices are roughly $10/barrel above their estimates from April. Higher energy prices have helped some metrics like trade dollar volumes, but they also trickle into every aspect of the cost of living.
Rate cuts can help with the slowing economy and weak investments, but they will certainly boost inflation. That leaves the BoC with a rough tradeoff: cut too soon and risk fuelling inflation, or hold too long and deepen the slowdown.
“There may be a need for consecutive increases in the policy rate,” warned Governor Macklem.
