Bank of Canada holds rate at 2.25% as oil prices cloud outlook

The Bank of Canada held its main interest rate at 2.25% but warned it would act quickly if the impact from higher energy prices spreads, a message that came as renewed geopolitical conflict sent Brent crude futures soaring 6% to about $114.50 a barrel.

"If energy prices stay high, we will not let their effects become persistent inflation," Governor Tiff Macklem said in testimony to lawmakers on Monday, reinforcing the bank's commitment to its inflation target.

The hawkish commentary caused fixed-income traders to price in the likelihood of two rate increases before the end of 2026. The Canadian dollar held steady against its U.S. counterpart, supported by the prospect of higher rates and data showing Canada’s trade balance unexpectedly swung to a C$1.78 billion surplus in March. U.S. oil futures also climbed 4% to $106 a barrel.

The central bank faces a delicate balancing act between containing inflation and navigating significant trade risks. While Macklem signaled a readiness to hike rates, he also acknowledged that a new round of trade threats from the U.S. this summer could damage confidence and require rate cuts to soften the blow.

Inflation's Uncertain Path

The central bank's current projection sees inflation peaking around 3% in April and gradually easing toward its 2% target by early 2027. However, this forecast rests on a critical assumption: that crude-oil prices decline to $75 a barrel by mid-2027. The recent surge in oil prices, stemming from flared tensions in the Iran war, puts that assumption at risk.

Macklem told lawmakers that an increase in core inflation, which excludes volatile items like food and energy, would be a key warning sign that price pressures are becoming more broad-based. "It's going to depend a lot on what actually happens with global oil prices. It's going to depend on companies, whether they absorb those prices or they pass them through," he said. While higher rates would hurt households and small firms, Macklem stated, "the alternative is to let inflation get out of control. That hurts everybody even more."

Trade Headwinds Gather

Complicating the bank's calculus are renewed trade tensions with Canada's largest trading partner. A U.S.-led review of the U.S.-Mexico-Canada trade treaty (USMCA) is set for this summer, and talks between Ottawa and Washington have stalled. Macklem acknowledged the risk, noting the U.S. may "come out with new threats, and they may make a lot of noise."

This uncertainty creates a counterweight to the inflationary pressures from energy. A serious trade dispute could dampen business investment and household confidence, forcing the Bank of Canada to consider rate cuts to support the economy, directly opposing the action needed to tackle inflation. For now, as one economist noted, "wait and see is the mantra—for now—but the clock is ticking."

This article is for informational purposes only and does not constitute investment advice.