Bank of Canada signals hawkish stance: does not want to act too slowly on rate hikes, oil prices become key risk

Bank of Canada Governor Macklem said that if inflationary pressures show more persistent signs, policymakers do not want to act too slowly on rate hikes. As Middle East conflicts push up energy prices, the risk that Canadian inflation remains elevated is rising, and monetary policy may need to respond. According to the text of a speech Macklem delivered Monday in Halifax, Nova Scotia, he said the Bank of Canada neither wants to raise borrowing costs and suppress economic growth when inflationary pressures are under control, nor does it want to react too slowly when inflationary pressures become more persistent. These remarks continued the hawkish policy tone the Bank of Canada has struck since this month's interest rate meeting. The Bank of Canada kept its policy rate unchanged at 2.25% on September 2, but stressed that continued high energy prices caused by Middle East conflicts have increased the upside risks to the inflation outlook. Macklem pointed out that Canada's consumer price index (CPI) year-on-year increase has recently remained around 3%, largely driven by higher gasoline prices. If oil prices continue to remain near $100 per barrel, the Bank of Canada expects overall inflation to rise slightly further in the coming months. For now, signs that high energy prices are spilling over into other goods and services prices remain limited. Data previously released by the Bank of Canada showed that excluding gasoline, Canada's inflation rate in July was 2.2%, and core inflation measures also remained around 2%. However, as the Middle East conflict continues and energy prices stay high, the Bank of Canada is increasingly worried that energy costs will eventually pass through to broader consumer prices. The Bank of Canada made clear at its September policy meeting that the longer oil prices and refining margins remain high, the greater the risk that higher energy prices evolve into more persistent and broad-based inflation. If such pass-through eventually occurs, monetary policy may need to respond. This means that although Canada's economy still has some slack, energy prices have become an important variable affecting the Bank of Canada's next phase of interest rate policy. Compared with its vigilance over inflation risks, Macklem was relatively less pessimistic about the overall economic impact of the latest round of U.S. tariffs on Canadian goods. He acknowledged that the new tariffs will deal a clear blow to directly affected industries, and that uncertainty over trade policy may also prompt businesses to further delay investment and hiring plans. But for Canada's overall economy, the Bank of Canada does not expect the new round of tariffs to have a huge direct impact. Bank of Canada data show that goods affected by the new U.S. tariffs account for about 5% of Canada's goods exports to the United States, while support measures introduced by the Canadian federal government are expected to offset some of the losses. However, the indirect effects of trade friction should not be ignored. The Bank of Canada believes that uncertainty surrounding Canada-U.S. trade relations could weigh on business and consumer confidence and further drag on business investment, hiring, and household spending. Macklem said that if these new tariffs remain in place, Canada's fourth-quarter economic growth could be roughly halved, falling below 1%. Faced with multiple uncertainties including energy prices, trade friction, and geopolitics, the Bank of Canada is also adjusting its economic forecasting tools. Macklem revealed that the Bank of Canada has developed a new forecasting model called "Prima," aimed at helping policymakers better distinguish temporary inflation shocks from price pressures that may last longer. The model will be used for the first time in the next Monetary Policy Report to be released in October and will help the Bank of Canada assess different economic scenarios. The Bank of Canada's next interest rate decision is scheduled for release on October 28, when the latest Monetary Policy Report will also be published.