Published on: July 31, 2025
The Canadian and US central banks announced their respective decisions on their policy rate on Wednesday. In line with market expectations, the Bank of Canada (BoC) kept its rate at 2.75% for the third consecutive meeting, while the US Federal Reserve (Fed) maintained its range between 4.25% and 4.50%.
The BoC Seems to Trivialize Inflation
The Canadian central bank explains its recent decision by pointing to the persistent threat of new sectoral tariffs. It also refers to the considerable uncertainty reflected in its Monetary Policy Report.
Despite upward pressure on inflation and political instability in the US, Bank of Canada Governor Tiff Macklem expressed optimism at the press conference. “US tariffs have disrupted trade in major economies and are slowing global expansion, but to a lesser extent than expected,” he noted.
Here are a few observations made by the BoC in its most recent Monetary Policy Report:
In its report, the BoC appears to overlook crucial factors such as cost push, the past effects of monetary easing on inflation (such unfavourable cost pressures being inconsistent with price stability), and structural factors in Canadian labour market dynamics. According to its analysis, everything can be explained by real GDP growth relative to potential, which is not observed but estimated by the central bank, and therefore based on the output gap.
In reality, inflation certainly does not result from a single factor. We therefore wonder how the Bank Governor reconciles his measure of excess supply in the Canadian economy, which has deteriorated since April, with the reflation observed in his two preferred measures. In fact, the two measures of core CPI preferred by the Bank of Canada clearly showed acute reflation in 2025, which is inconsistent with an economy in a situation of excess supply.
The BoC appears to place too much emphasis on the traditional core CPI and not enough on its two preferred measures (weighted median and trimmed mean). The traditional CPI clearly undershot both of these measures, and the Bank again responded strongly based on this price index. In fact, it seems too eager to blame customs duties rather than its own contribution, namely a quick and large monetary policy easing over the last year, on these inflation measures which are still running at 3%.
The Fed Limits Its Analysis of the Labour Market
The US central bank justified its decision to keep its key policy rate unchanged, citing moderate economic growth and high uncertainty about the outlook. It also notes the low unemployment rate and the strength of the job market. However, the Fed notes that the FOMC will continue to closely monitor the implications of incoming information for the economic outlook.
At the press conference following the monetary policy announcement, Fed Chair Jerome Powell said that “higher tariffs have begun to show through more clearly into prices of some goods but their overall effects on inflation and the economy remain to be seen. Their effects on inflation could prove to be short-lived, but it is possible the inflation effects could be more persistent.”
The Fed’s decision was not supplemented by an update of the economic forecasts. Here are some key points regarding this decision:
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Inflation figures are still above the central bank’s 2% target.
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New GDP data showed that the economy grew by 3% between April and June.
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Inflationary pressures were slightly stronger than expected.
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For the first time since 1993, two Fed governors opposed the majority decision.
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In December, the FOMC pencilled in two interest-rate cuts for 2025.
Chairman Powell insists that US labour market conditions remain strong, which is not consistent with our interpretation of the data. During the question-and-answer session, he even stated that “conditions are broadly in balance.” However, very few sectors are creating employment. While it is true that, overall, the labour market gap is balanced, this analysis only considers quantity data from the US labour market.
The labour market gap compares supply (employment + unemployed) and demand for labour (employment + job openings) as a percentage, based on millions of people. The labour supply now stands at 170.4 million, while demand stands at 170.8 million, a difference of only 400,000, which can be described as an overall balance, but only in quantity terms. The same applies to the unemployment rate, which is calculated solely based on certain labour market data (unemployed/labour force).
Regarding the subsequent distribution of price increases passed on to consumers, Chairman Powell stated, “We just don’t know the distribution yet,” which is false. We know that the tariffs have not been passed on to consumers to any significant extent so far. President Powell has decided to disregard this fact and is currently counting on an increase in the impact in the future. If the effective tariff rate does not increase significantly in the future, the Fed may be surprised on the downside regarding inflation (compared to its latest forecasts), which is exactly the opposite situation of what we wrote previously for the Bank of Canada.