The Bank of Canada (BoC) held its policy rate at 2.25%, in line with market expectations.
The Opening Statement made clear that uncertainty is higher than before as the “war in Iran has added a new layer of uncertainty”. The total impact of the shock is uncertain but “how long the conflict lasts and the extent to which it spreads across the Middle East” are two key factors that were cited.
Since January, the economy has grown “at a slower pace” than the BoC forecast. However, given the inflation shock, the BoC noted that this “excess supply” is helping to contain the “risk that higher energy prices quickly spread to the prices of other goods and services.” But the Bank also struck a dovish note, pointing out that “relative to our January forecast, risks to economic growth are tilted to the downside.”
Most importantly the statement highlighted that, “Governing Council will look through the war’s immediate impact on inflation but if energy prices stay high, we will not let their effects broaden and become persistent inflation”.
Key Implications
No real surprises here. The BoC stayed on hold as expected and highlighted the uncertainty coming from the energy shock. The emphasis on keeping inflation pressures from spilling over from energy to other categories was to be expected. What matters in the coming months will be how the assessment and identification of those spillovers are communicated.
The war in the Middle East is the dominant factor here. How long it disrupts supplies of energy products and other goods is the determinant of how big the associated inflationary impact will be. The BoC is focused on the pass-through to core prices and any shifts to inflation expectations. Given a domestic economic backdrop that has featured still-elevated unemployment, softening core inflation and growth risks “tilted to the downside”, we expect the Bank of Canada to stay on the sidelines, for now. However, uncertainty is high and the supply shock could easily escalate, broadening inflation beyond energy prices. In the event that both core inflation and inflation expectations drift higher we would expect the BoC to be ready to respond.
