The Bank of Canada maintained its key policy rate at 2.25% on Wednesday, as widely anticipated, but Governor Tiff Macklem was clear that the central bank stands ready to raise rates if higher energy costs risk becoming a lasting inflationary force.
Macklem told reporters that the conflict in the Middle East is expected to push gasoline prices higher and add to inflationary pressure in the near term. "It is too early to assess the impact of the war on growth in Canada," he said, adding that, for now, the risk of higher energy prices quickly spreading into prices for other goods and services appeared contained.
He reiterated the Bank of Canada's approach to the shock: "Governing Council will look through the wars immediate impact on inflation but if energy prices stay high, we will not let their effects broaden and become persistent inflation." The bank has held its policy rate at 2.25% since last October.
Before the onset of the conflict, inflation in Canada had been near the central bank's 2% target for several months, and the bank's policy stance had been viewed as moderately stimulating a weak economy. Macklem warned that the situation presents a policy dilemma: "Economic weakness combined with rising inflation is a dilemma for central banks," he said. "Raising interest rates to slow inflation could further weaken the economy. Easing interest rates to support growth risks pushing inflation well above target."
Economists cited by the bank say the impact of higher energy prices on inflation and growth would depend on the duration of any disruption to shipping routes. They note that if the Strait of Hormuz - which handles about a fifth of global oil trade - remains closed for more than a few weeks, forecasts for inflation and growth would be affected.
Financial markets adjusted their expectations after the announcement. Money markets, which had previously priced the Bank of Canada to stay on the sidelines through 2026, moved to firm up bets on a rate hike in December.
The Canadian dollar weakened following the decision, trading down 0.20% to C$1.3717, equivalent to 72.90 U.S. cents.
Macklem said near-term Canadian growth was likely to be weaker than the bank had forecast in January and described the level of uncertainty facing the economy as acute. He highlighted a range of domestic challenges, including U.S. tariffs affecting some critical sectors, subdued business investment, a soft labour market and uncertainty over the future of the free trade agreement between the U.S., Mexico and Canada.
"Canada's economy is dealing with a lot, and now we face more volatility," Macklem said, underlining the balance policymakers must strike between supporting growth and keeping inflation anchored.
Key points
- The Bank of Canada held its policy rate at 2.25% and signalled readiness to raise rates if energy-driven price rises become persistent.
- The Middle East conflict is expected to push gasoline prices higher, producing short-term inflationary pressure; the risk of broader pass-through is judged contained for now.
- Near-term growth is expected to be weaker than the January forecast amid acute uncertainty, while markets have moved to price a later-year rate hike.
Impacted sectors and markets
- Energy - higher gasoline prices directly affect consumer energy costs and can influence inflation measures.
- Financial markets - interest-rate expectations and currency values reacted to the bank's guidance.
- Trade-exposed industries - tariffs and uncertainty around the trilateral trade agreement may weigh on investment and trade flows.
Risks and uncertainties
- Prolonged disruption in oil shipping routes - If the Strait of Hormuz remains closed beyond a few weeks, economists say forecasts for inflation and growth would be affected.
- Pass-through of energy costs - While currently judged contained, sustained high energy prices could spread to other goods and services and become persistent inflation.
- Domestic economic pressures - U.S. tariffs on some critical sectors, subdued business investment, a soft labour market and unclear trade arrangements add to economic uncertainty.
The Bank of Canada's decision to pause at the current policy rate reflects a careful weighing of weak near-term growth against the risk of renewed inflationary pressure from energy markets. Officials signalled they will look through immediate, temporary shocks from the conflict but will act if elevated energy costs begin to feed into broader price pressures.