Bank of Canada stands pat, explicitly "looking through" short-term oil price shocks, focusing on downside growth risks

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On March 18, the Bank of Canada announced that it would keep interest rates unchanged, making it clear that it would "look through" the short-term impact of the Middle East conflict on inflation, and anchor its policy focus on downside risks to economic growth.

The policy committee led by Governor Tiff Macklem kept the policy rate at 2.25%, in line with market expectations and most economists surveyed by Bloomberg. The central bank's statement said, the economic impact of the Middle East conflict is "highly uncertain" and its duration and scale cannot be predicted. At the same time, the bank removed the phrase “current policy rate remains appropriate” from its January statement, instead stating it is "ready to respond as needed," expressing a more flexible stance.

Macklem stated that due to continued trade frictions leading to excess supply in the economy, the risk of inflation rising in Canada is expected to be contained, and inflation is currently close to the central bank's 2% target. After the rate decision was announced, the Canadian dollar continued its decline, falling 0.2% against the US dollar during the day.

Growth Risks Skew to Downside; Employment Data Alarming

Although rising oil prices will push up inflation in the short term, the central bank explicitly pointed out "growth risks skew to the downside" and cited a series of weaker-than-expected economic data as evidence.

In the labor market, Canada's employment shrank by 83,900 in February, marking the largest monthly drop in four years, with the unemployment rate rising to 6.7%. Meanwhile, the economy also faces multiple headwinds including slower population growth and trade war impacts, causing Q4 GDP to contract at an annualized rate of 0.6%.

Macklem said, although sustained oil price increases will "boost energy export revenues," higher gasoline prices will also "squeeze consumer disposable income and reduce spending in other consumption sectors," so the actual boost is limited.

The Double-Edged Effect of Oil Price Shocks

As the largest foreign crude oil supplier to the US, Canada’s sensitivity to oil price fluctuations differs from other economies. If oil prices continue to rise and remain high, they will bring considerable revenues to governments and companies in the energy-rich provinces; but the knock-on effects are equally notable.

Macklem warned that the Middle East conflict has tightened global financial conditions—leading to higher global bond yields, falling stock markets, and widening credit spreads. He also specifically mentioned that transportation bottlenecks in the Strait of Hormuz "may affect the supply of other commodities such as fertilizers," and potential spillover effects deserve attention.

Markets and Economists: Dovish Tone Is Apparent

Many market analysts believe that the central bank’s statement this time is more dovish than what the market had priced in.

Benjamin Reitzes, Montreal Bank rate and macro strategist, wrote in an email: “The tone of the policy statement is dovish, especially compared to market pricing. Before more information is available on the duration and scale of the energy price shocks, policy will remain unchanged. If not for this conflict, the central bank would clearly be more concerned about the outlook and its stance would be even more dovish.”

Jason Daw, head of North American rate strategy at RBC Capital Markets, said on BNN Bloomberg: “The outlook was already unclear weeks ago, and the oil price issue has made it even more complicated. All of this shows the central bank will keep policy unchanged for a longer period as it digests relevant information.”

CIBC chief economist Avery Shenfeld wrote in a report to investors that the central bank “gave no indication of any discussion of rate hikes or cuts at this meeting,” which is consistent with its position—the impact of energy price shocks critically depends on their duration, and “this is simply unknowable at present.”

Holding Steady May Not Last

Although the decision matches expectations, some economists warn the window for keeping rates unchanged may not last long.

Andrew DiCapua, chief economist at the Canadian Chamber of Commerce, said in an email: “The Bank of Canada may be holding steady, but this stance may not last long. While rising oil prices are exerting real cost pressure on Canadians, inflation risks remain low. The Governor acknowledged the asymmetric trade-offs posed by high oil prices for the Canadian economy.”

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