With the trade war, the Bank of Canada had no choice but to hold rates

Published in the Globe and Mail.

The Bank of Canada held its policy rate constant at 2.25 per cent on Wednesday, meeting market expectations. But if not for developments on the trade front, the economic data could well have pointed toward a hike. With the breakdown in Canada-U.S. trade negotiations and the resulting economic uncertainty, the bank had little choice but to hold.

To see how powerfully the trade story influenced the bank’s decision, consider the case for a hike had negotiations not broken down.

On Aug. 28, Statistics Canada published its estimate of second-quarter gross-domestic-product growth. Growth came in above expectations: 3.3 per cent on an annualized basis. That reversed the first-quarter weakness in GDP. Indeed, the first-quarter GDP growth numbers were revised up, turning a 0.1-per-cent annualized contraction into a 0.3-per-cent increase. For those who had asked whether Canada was in a recession following the fall in fourth-quarter 2025 GDP and the originally reported decline in the first quarter of 2026, the answer is now clearly no.

Second-quarter growth was boosted by surprisingly strong growth in business investment, up 9.5 per cent at annualized rates. But growth wasn’t limited to business investment: Consumption rose 3.3 per cent and exports 14.3 per cent.

After easing from 3.2 per cent in May to 2.6 per cent in June, headline inflation increased to 3 per cent in July, back at the upper end of the Bank of Canada’s 1-per-cent to 3-per-cent control range.

Yes, a big part of that 3-per-cent figure is due to energy prices – without energy, inflation was 2.2 per cent. But crude oil prices have moved back up from under US$70 per barrel at the beginning of July to close to US$90 at the end of August, well above the US$75 per barrel projected in the bank’s last Monetary Policy Report. And with no end in sight to the conflict in the Persian Gulf, that pressure could persist.

While we continue to see little evidence of this energy shock spreading to other sectors, the bank will want to remain vigilant about that risk. This is especially the case as growth is widespread, with the C.D. Howe Institute’s diffusion index – which measures the breadth of growth across sectors – reaching its highest three-month average since May, 2024.

Put all this data together, and there might have been a compelling case for the bank to hike.

But despite rumours that an agreement was close, Canadian negotiators walked away from trade talks on Aug. 21. In response, the United States immediately imposed 50-per-cent tariffs on a range of Canadian goods. Prime Minister Mark Carney then announced dollar-for-dollar retaliatory tariffs, set to come into effect on Sept. 8.

The ultimate impact on prices faced by Canadians is somewhat unclear. On the one hand, few U.S. industries depend exclusively on Canadian buyers. With alternative export markets, U.S. producers will not cut their prices, meaning the cost of the countertariffs are passed through almost entirely to Canadian consumers and producers. On the other hand, in industries where Canadians can buy from alternative markets, American producers may have to cut prices to remain competitive in the face of the countertariffs.

Critically for an inflation-targeting central bank, the long-run effect (if these tariffs remain in place) will be on the level of prices. Inflation will increase in the short run, but then revert to its pretariff trend, although with prices on a higher path.

Regardless, the tariffs imposed by the U.S., our countertariffs and a continuing trade war will hurt affected Canadian industries and the economy writ large. Non-energy investment in Canada will take a hit as some Canadian firms contemplate holding off on investing until the Trump administration ends or, perhaps worse, moving their operations south of the border. Household spending is likely to suffer. Should the tariffs take effect and stay in place, some predictions point to job losses in the tens of thousands.

If that scenario comes to pass, it would push the Bank of Canada, all else equal, toward a rate cut to give a boost to the economy.

Ultimately, the bank was faced with not just data suggestive of potential inflationary pressures, but massive trade uncertainty that threatens our market access to the world’s largest economy. We see no other choice for the Bank of Canada under these conflicting circumstances than to hold.

Jeremy Kronick is president and chief executive of the C.D. Howe Institute, where Steve Ambler, emeritus professor of economics at Université du Québec à Montréal, is the David Dodge Chair in Monetary Policy.