The Bank of Canada‘s upcoming interest rate decision has become a focal point of speculation among market analysts, as uncertainty shrouds the central bank’s next move. At today’s pricing, that is just a 6 bp pickup. The real decision is about very carefully weighing a lot of different economic indicators. Furthermore, market forecasts suggest a potential 15 bp increase in July, highlighting an atmosphere of unpredictability as stakeholders await clarity.
The potential fallout From the recent economic data, Canada’s GDP growth has continued to exceed expectations. For the first quarter, it came in quite strong at an impressively robust 2.2% annualized rate. As there was no new demand, this growth was artificially inflated by front-loading ahead of expected tariffs. This is a great figure on the surface. At the same time, it clouds over some grave emerging storms in the economy, none more so than the stagnating consumer spending and a plunge in business investment.
Economic Growth and Challenges
The strong GDP growth rate has come at the hands of some unusual contributors, such as higher inventories and net exports. These factors combined to hugely inflate the economy as companies scrambled to prepare for the shock of soon-to-be-announced tariffs. We should be heartened by these positive indicators, but the broader economic landscape continues to be a mixed bag.
With consumer spending now stalling, those monthly increases in growth might not be sustainable over the next month and months ahead. After peaking, business investment has plummeted. This drastic decrease is a sign that businesses lack the confidence to move forward with long-term investments with continued uncertainty on the future of trade. These cumulative effects make up an already challenging landscape for the Bank of Canada as it tries to steer the economy through troubled waters.
As the economic landscape continues to evolve, the state of the Canadian dollar (CAD) finds itself in potentially stretched overvaluation territory. Despite this positive outlook, analysts still warn that the CAD could experience serious downside risks that would hurt its performance against the other major currencies. More appropriately, given the recent volatility in the USD/CAD exchange rate, the Canadian dollar is more than 3% undervalued against its short-term fair value. This emerging situation further complicates an already precarious monetary policy environment.
Employment and Inflation Concerns
A second, equally urgent worry for the Bank of Canada is the state of the labor market. Currently, reports are warning that unemployment is at risk of crossing 7%, a level that would start sounding alarm bells for policy makers. And luckily for us, a climbing unemployment rate would provide the central bank cover to think about more dovish monetary ideas aimed at accelerating job creation.
At the same time, core Consumer Price Index (CPI) has started to move back up again. This sharp rise in inflation creates a real conundrum for the Bank of Canada. More importantly, it needs to deliver strong enough interest rate control for the economic growth and full employment that’s needed. The central bank’s decision-making process is further complicated by external factors, particularly the ongoing trade war between Canada and the United States.
Trade War Implications
The continuing US/China trade war still represents the most serious threat to uncertainty over Canada’s economic prospects. Recent developments, including the announcement of US steel and aluminum tariffs on Friday, have reignited concerns over international trade relations. The erratic character of the trade war – with President Trump tossing surprises on a daily basis – further complicates the Bank of Canada’s task.
As decisions are made by our elected leaders, letting outside priorities dictate economic conditions at home is a frustratingly avoidable reality that must be prevented. Trade policies and Canada’s economic prosperity are inextricably linked. This will be an important dynamic guiding the central bank’s policymaking in the coming months.