When the Bank of Canada (BOC) left its policy rate unchanged at 2.75% on June 4th, 2025, it marked only the second pause since April 10th, 2024. The Governing Council cut interest rates by either 25 or 50 basis points at the other seven meetings, in an attempt to support the Canadian economy through the economic uncertainty and mitigate the strain on borrowers and low-income households.

 Now, U.S. tariff policies and their impact on inflation and growth have clouded the BOC’s outlook. At the June meeting, Governor Tiff Macklem emphasized that the trade dispute with the United States remains the primary challenge. While the Canadian economy has remained resilient, the acceleration in exports in the first quarter borrowed economic strength from the future, leading to weaker expected output in Q2. Moreover, he noted  that recent surveys indicate Canadians are bracing for higher prices and many businesses intend to pass on tariff costs to consumers.

As a result, “there was a clear consensus to hold policy unchanged as we gain more information.”

Despite Tariffs, the Long-Term Trend Remains Intact

The disinflationary trend continued on May 20th, as Canada’s Consumer Price Index (CPI) hit 1.7% year-over-year (YoY) in April, down from 2.3% in March and 2.6% in February. The deceleration was driven by a 12.7% decline in energy prices versus a 0.3% decline in March.

The BOC expressed optimism that long-term metrics will continue to drift toward 2%, and at the June meeting, Macklem noted that the removal of the consumer carbon tax “knocked 0.6 percentage points off inflation in April, largely due to lower gasoline prices, and pulled headline inflation down to 1.7%.” In addition,wage growth fell from 3.6% Year over Year in March to 3.4% YoY in April, and the slowdown could help limit consumer spending and corporations’ pricing power.

As for the short term, tariffs are the primary inflation driver, and like the BOC, we are all left waiting for a final trade resolution and clarity regarding the potential fallout.

Likewise, the Israel-Iran conflict further complicates the BOC’s short-term outlook. There is currently a ceasefire in place which appears to be holding and oil prices have eased as a result  but the situation has the potential to remain tenuous. On the one hand, Canada is the fourth-largest oil producer in the world, and the recent spike in the Western Canada Select (WCS) price supports higher exports, economic growth, and employment. On the other hand, higher oil prices increase heating, gasoline, and fuel costs for Canadians. As such, while the inflationary impact would likely be temporary, the political situation could re-escalate and the BOC needs to assess the ramifications to determine the appropriate path of monetary policy during the summer months.

Lack of Visibility on Forward Guidance

Given the uncertain economic backdrop, Macklem said, “We are being less forward-looking than usual.”

The decision allows for further evaluation of U.S. trade policies and their potential impacts, and he said the BOC will monitor both the downward pressures on inflation resulting from a weaker economy and the upward pressures stemming from tariffs.

The main variables the Governing Council are watching include: the extent to which higher U.S. tariffs reduce demand for Canadian exports, the potential spillover effects on business investment, employment, and household spending, the speed and magnitude at which cost increases are passed on to consumers, and how inflation expectations evolve over time.

While it’s still unclear how the outlook will evolve, a de-escalation with the U.S. remains likely and should lead to lower inflation and a more stable and predictable economic environment. Moreover, given inflation’s impact on long-term interest rates, housing market activity could pick up as lower mortgage rates stimulate demand for new and existing homes.

Expect more compression in variable and fixed mortgage rates as we approach the second half of 2025. The BOC should confront further disinflation, and rate cuts should reduce prime rates and short-term borrowing costs. Likewise, softer economic growth could pressure long-term interest rates and make financing more affordable for prospective homeowners.