Bank of Canada Preview: Everything Everywhere All at Once

The Bank of Canada is in uncharted territory. Canadian central bankers had contingency plans in place for either upside risks to inflation from higher-than-expected oil prices or downside risks to growth from an escalation in the trade war. Persistently elevated oil prices would lead to rate hikes, while a deterioration in trade relations with the US would lead to cuts. What they didn’t say is how monetary policy would respond if both of those risks materialized simultaneously.

Brent oil prices remain around US$90 a barrel, well above the US$75 assumed in the July Monetary Policy Report. Elevated crack spreads are a separate issue also keeping gasoline prices high and adding upstream cost pressures for businesses.

The silver lining is that, on net, higher global oil prices are also supporting the Canadian economy. While there’s significant regional disparity, the Bank of Canada sets policy for the national economy. Activity in the oil patch has increased, and the industry has signalled a greater appetite for investment in recent months such that Q2 and Q3 GDP are tracking above the Bank of Canada’s July projections.

But another round of US tariffs has poured cold water on the economic outlook. The latest escalation in the US–Canada trade dispute will further discourage non-energy investment and leave household spending on shakier ground. If the dispute isn’t resolved soon, non-oil-producing provinces could see their economic forecasts marked lower, taking the national outlook down with them. Should the tariffs persist, even the $7.5B in support for workers and businesses announced by the federal government won’t be enough to fill the hole. At the same time, Canada’s retaliatory tariffs will add further upward pressure on consumer prices.

The Bank of Canada hasn’t recently outlined a playbook for dealing with both upside inflation risks and downside growth risks. At a time when the nation’s economy is under assault, it could be argued that monetary policy needs to row in the same direction as fiscal policy. But taking a step back, the Bank of Canada’s inflation mandate dictates that monetary policy respond to price pressures ahead of growth concerns when the two are in conflict.

So, while officials will signal a readiness to deliver easing if the economy shows severe signs of stress, they won’t be lowering interest rates next week given the outlook for inflation. The most likely course of action is for central bankers to remain on the sidelines for the rest of 2026. Come 2027, it still seems like the Bank of Canada will need to raise rates rather than cut them.

Upstream inflationary pressures from energy and retaliatory tariffs will filter through to headline CPI. Moreover, a recovery in population growth and fading mortgage-renewal headwinds should provide at least a modest lift to consumer spending and regional housing markets that have been under pressure. As a result, despite the latest trade tensions, markets are right to still brace for rate hikes next year. However, the degree of tightening embedded in bond yields is too aggressive.

Markets now assume that the Bank of Canada will take the policy rate above 3.00%. However, as we’ve written before, permanently higher tariffs would lower the potential growth rate of the economy, putting downward pressure on the neutral rate of interest. Despite all of the crosscurrents, we still see the Bank of Canada only raising rates to 2.75% in 2027. As a result, there’s room for bonds to rally even if the Bank of Canada doesn’t cut rates.