Published on: January 30, 2026
Central banks on both sides of the border announced their respective policy rate decisions on Wednesday. Unsurprisingly, the Bank of Canada (BoC) kept its rate at 2.25% for a second consecutive meeting, while the US Federal Reserve (Fed) maintained a range between 3.50% and 3.75%.
The BoC Downplays Inflation Once Again
The Bank of Canada justifies its decision by the weak evolution of the Canadian economic outlook in recent months. It also mentions the fragility of the outlook for its Monetary Policy Report due to the unpredictability of US trade policies and geopolitical risks.
At the press briefing, Governor Tiff Macklem repeatedly referred to the economic context caused by US protectionism. He also stated that the economy had evolved in line with the central bank’s forecasts since the end of its monetary easing cycle. As the Canadian economy continues to adjust to US trade restrictions, “We anticipate modest GDP growth and expect inflation to remain close to the 2% target,” he said.
Here are a few observations made by the BoC in its most recent Monetary Policy Report:
In its narrative, the Bank of Canada reiterates that economic growth should remain modest in 2026. It hastily assumes, to say the least, that the inflation problem has been solved. From 2.1% in 2025, inflation is expected to remain close to the 2% target over the projection period, as trade-related cost pressures are offset by excess supply. However, this factor has little impact on inflation, namely -0.2 percentage points. Conveniently, the BoC also seems to overlook the positive base-year effect of last April’s abolition of the carbon tax, which could boost total inflation by 0.7 percentage points. If inflation has decreased because of the carbon tax cut, how can we assume that it won’t rise again when its effect wears off?
The BoC expects real GDP growth of 1.1% this year, with domestic demand at 1.7%. Although we consider consumption to be somewhat weak, this forecast is not far removed from our own GDP growth breakdown, given that we are predicting 1.4% growth this year. Our main point of divergence with the Bank of Canada lies in the inflation outlook. According to the central bank, global CPI will remain very close to the 2.0% target, while our base case scenario is around 2.7%. This is yet another example of its tendency to minimize inflation, this time by means of a very unclear “other” component. We believe that understanding this offsetting factor is crucial, yet the BoC seems to be failing to address it.
Finally, the diffusion of inflation index has deteriorated sharply recently, with almost 50% of all CPI basket prices having risen by more than 3.0%. The BoC suggests that this is due to food prices, but inflation in services, excluding housing, is now 4.5% and accounts for 28% of the overall CPI basket. Thus, if the central bank is wrong regarding this “obscure disinflation black box,” inflation will rise in the spring in Canada, since the removal of the carbon tax rebate should be the main factor explaining some total CPI reflation in Canada.
Excessive Optimism and Pessimism From the Fed on Different Fronts
The US central bank justified its decision by citing “robust” growth, suggesting that the US economy does not need further support. It also points out that the unemployment rate, which stood at 4.4% in December, “has shown signs of stabilization.”
Two members of the FOMC (the monetary policy committee) spoke out against the decision at the end of a two-day meeting. Governors Christopher Waller, a candidate to succeed the current Fed Chairman, and Stephen Miran have argued in favour of cutting interest rates by a quarter of a percentage point.
The Fed provided no details as to when a further reduction in borrowing costs might occur, indicating that “the magnitude and timing of further adjustments” would depend on future data and the economic outlook.
The announcement of the Fed's decision was not accompanied by an update of its economic forecasts. Here are some key points regarding this decision:
According to the Fed, the unemployment rate is showing “signs of stabilization”. This observation may seem somewhat surprising from a central bank, given that only one monthly report showed a reversal in the official unemployment rate. The upward trend observed since 2023 is clear. December’s unemployment rate drop could easily be part of normal monthly data volatility. The expanded definition of the US unemployment rate (U6 rather than U3, which includes a larger proportion of the population) has accelerated its increase recently.
During his allocution, Fed Chairman Jerome Powell seemed to place great emphasis on the recent strength of real GDP, which has indeed accelerated. That said, it was also a response to the strong performance of productivity growth. Thus, most of the last two quarters have been dominated by productivity. In his Q&A session, Chairman Powell almost alluded to the fact that stronger growth would ultimately lead to more jobs, which is not obvious to us in a world dominated by productivity, AI and the contribution of just two sectors to job creation.
At some point, the labour market will have to accelerate in terms of monthly job creation; otherwise real consumption growth will slow down. It is expected to fall to 1%, from the current 2.5%, unless job creation accelerates. Current year-on-year growth rates in real income and consumption are decoupling (1.0% for real income and 2.5% for real consumption). Again, this is not sustainable, but the Fed isn't talking about this dynamic.
Finally, on the inflation front, the latest data were more consistent with our baseline scenario of PCE inflation below 2.0%, as median PCE inflation was just 0.1% month-on-month over the last three consecutive months of data. Moreover, powerful disinflationary forces are being exerted on PCE durable goods inflation from the January report onwards. The next report, for December, will not be favourable, as durable goods fell during December 2024. However, from January 2025 to June 2025, monthly growth rates were high, so significant disinflation will be seen in the first half of this year, and the good news is that this impact will be felt more quickly on PCE inflation than on CPI data.