The Bank of Canada is expected to keep rates steady as the economy stagnates

The Bank of Canada is expected to wind down its monetary policy tightening campaign this week, weighing stubborn inflation data against growing evidence that the Canadian economy is starting to stall.

Analysts expect the central bank to keep its key interest rate on hold at 5 percent on Wednesday after raising it in June and July.

According to polls and swap market data, there is widespread belief on Bay Street that Canadian interest rates have peaked and no further hikes are needed to bring inflation back under control. But economists do not expect the central bank to mark a formal end to its tightening campaign this week, given the risk of higher inflation.

Bank of Canada Governor Tiff Macklem said “We need to see more inflation pick up, and within a few months, we’ll have enough labor market slack for the bank to be comfortable saying rates are high enough to do jobs. „Canadian Imperial Bank of Commerce Chief Economist Avery Shenfeld wrote in a note to clients.

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„But if they avoid a hike in September, we expect the balance of risk calculations will eventually clarify that rates have indeed peaked for this cycle.”

The Bank of Canada first paused its tightening campaign in January, providing a brief reprieve for homeowners and other borrowers hit by eight consecutive rate hikes over the previous year.

This „conditional pause” did not last long. In June, Mr. Macklem and his team raised interest rates again in response to strong consumer spending and employment data, as well as an unwelcome surge in real estate prices in the spring. Central bankers raised rates again in July, warning that inflation may take longer than previously expected to reach the bank’s 2-percent target.

However, in the past month, key economic indicators have started to move in the direction the bank wants to see as it tries to slow the economy to curb inflation.

Canada lost 6,400 jobs in July, and the unemployment rate rose to 5.5 percent, up half a percentage point in three months. Meanwhile, lackluster retail sales data for late spring and early summer suggest Canadian shoppers are starting to leave.

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The strongest evidence of a slowdown came on Friday, with the release of weaker-than-expected GDP data. Economic activity shrank at a 0.2 per cent annual rate in the second quarter, with a hit to resource industries hit by the wildfires, led by a drop in new construction and a slowdown in consumer spending, Statistics Canada said. The Bank of Canada expects annual growth of 1.5 per cent in the quarter.

„Between the half-point rise in the unemployment rate over the past three months — a clear and present warning sign — and the big slowdown in gross domestic product, it’s clear that past rate hikes are now weighing heavily on households, and that’s one thing. Until that translates into cooling core inflation trends, „Bank of Montreal chief economist Doug Porter wrote in a note to clients.

But one key metric isn’t moving in the right direction: inflation. Annual consumer price index inflation rose to 3.3 percent in July from 2.8 percent in June, falling back from the central bank’s 1 percent to 3 percent target range. Some measures of core inflation, which filter out volatile price movements, were lower. But most of these operations continue to run at 3.5 percent to 4 percent.

Inflation has come down sharply from 8.1 percent reached in June, 2022. But much of this inflation has come from favorable year-over-year oil-price comparisons, which no longer weigh on the CPI. In July, Mr. Macklem warned.

Interest-rate hikes work with considerable lag, and the Bank of Canada sets monetary policy based on where inflation is headed, not where it is today. That means central bankers must balance the risk of doing too much and causing a painful recession against the risk of doing too little to control runaway prices.

This calculation is currently difficult, as rate hikes do not appear to be as powerful as they have been in the past. That has left central bankers wondering whether to raise rates further or give the economy more time to work their way through the economy.

One thing seems certain: even with signs of the economy entering a mild recession, interest rate cuts are almost never on the horizon, often defined as two quarters of negative growth.

„The Bank of Canada has a mandate — it has to maintain inflation at their target rate,” Nathan Johnson, assistant chief economist at the Royal Bank of Canada, said in an interview.

„So we think they’ll be more cautious about pulling back on the monetary policy brakes or pulling back interest rate hikes than they would have been in a normal economic cycle. They won’t be in a rush to cut rates when they see the economy starting to soften.

Wednesday’s rate announcement will be a one-sided affair, with no economic forecast. Mr. Macklem will deliver a speech in Calgary the next day, his first public comments since the July tariff announcement.