The “Great Advantage to Doing Nothing” on Interest Rates

To: Interest rate watchers
From: Jeremy M. Kronick and Steve Ambler
Date: April 23, 2025
Re: The “Great Advantage to Doing Nothing” on Interest Rates

After seven straight cuts, the Bank of Canada hit pause last week and held its policy interest rate at 2.75 percent.

We have argued over the last few months that the Bank needed to cut the overnight rate to at least get it back to the mid-point of the neutral rate range – where the economy is operating at potential and inflation is sustainably at the 2-percent target. The last cut to 2.75 percent achieved that. With conflicting data and the on-again/off-again US tariff dance, the Bank was right to pause. As former Bank governor David Dodge recently said: “There is actually a great advantage to doing nothing.”

What were the arguments in favour of a cut? Most revolved around uncertainty and the effect this would have on consumer spending and business investment.

The Economic Policy Uncertainty index for Canada has reached stratospheric heights. It has averaged a value of 164 since 1985, but has been moving up since the return of Donald Trump. When the trade war began in earnest at his inauguration in January, the index hit a never-before-seen 883. By March, it had soared to 1,542 – more than nine times the historical average. We are in the realm of what economists refer to as “Knightian uncertainty” or, as Donald Rumsfeld once said, unknown unknowns.

Financial institutions are also caught up in this uncertainty. The economic analysis departments of the major Canadian banks are updating their forecasts with dizzying frequency – and the predictions vary widely. Predictions of second-quarter economic growth range from negative 3 percent (annualized) on the low side to 1.2 percent on the high side. Of the Big Six banks, three were predicting two quarters of negative growth (the oft-used definition of a recession), one was predicting the economy to shrink only in the second quarter, and two were predicting growth to remain positive.

While the US administration has spared Canada in recent tariff announcements, its shifting focus to China is also a significant concern. A trade war between the two largest economies will lead to a global slowdown of economic growth and will harm Canada as well.

All this uncertainty will cause consumers to think twice about spending, and businesses to hesitate to invest – an area of the Canadian economy that was already weak.

So, why not cut again? Uncertainty plays a role here, too.

Conditions are so unprecedented that it is impossible even to assign probabilities to different scenarios. Governor Tiff Macklem had indicated in advance that this kind of uncertainty could lead the Bank to not publish a central scenario in the quarterly Monetary Policy Report. It followed through on that warning, instead publishing two “illustrative scenarios.” The last time it did not publish a central scenario was at the beginning of the COVID-19 pandemic.

The Bank’s recent surveys of consumer and business confidence show inflation expectations have actually been increasing in recent months. This is a nightmare scenario for a central bank: even as consumers cut back on spending and businesses on investment, they still expect inflation to increase. This also means that a policy rate of 2.75 percent has actually become looser in real terms, reducing the need for a rate cut.

The forecasting uncertainty is the major issue in our view. However, the Bank must, of course, also rely on the available data, and there are signs pointing to the wisdom of holding. Headline inflation (the change in the Consumer Price Index over the last 12 months) spiked to 2.6 percent in February. While mostly the result of the end of the GST/HST holiday, this was the first time it had been above the 2-percent target since last July.

Inflation numbers for March came out earlier last week, and, while softer at 2.3 percent, are still above target. The removal of the retail carbon tax and lower oil prices will continue to put downward pressure on inflation, but core inflation remains elevated and sticky at 2.9 and 2.8 percent for CPI-Median and CPI-Trim, respectively. And, the proportion of components of core inflation that exceeded 3 percent in March were 42 percent, up from 24 percent at the end of 2024.

A 50-50 view from markets on whether the Bank was going to cut is rare these days, with all the guidance central banks provide. But it reflects the times we live in with heightened levels of uncertainty. Lots of people were telling the Bank to “do something.” They were right to sit tight.

Jeremy M. Kronick is vice-president and director of the Centre on Financial and Monetary Policy at the C.D. Howe Institute, where Steve Ambler, a professor of economics at Université du Québec à Montréal, is the David Dodge Chair in Monetary Policy.

To send a comment or leave feedback, email us at blog@cdhowe.org.

The views expressed here are those of the authors. The C.D. Howe Institute does not take corporate positions on policy matter.

A version of this Intelligence Memo first appeared in The Globe and Mail.

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