As expected by the markets, the Bank of Canada (BoC) kept its policy rate at 2.25% on Wednesday. This seventh status quo since December 2025 reflects the central bank’s caution, as the economy remains resilient despite the lingering effects of high tariffs and the uncertainty surrounding the Trump administration’s decisions in Washington.
In its decision, the BoC stated that recent data supported its scenario of an economic rebound. It acknowledged, however, that inflationary risks had increased, particularly because of high oil prices.
“Economic growth in Canada has picked up after stalling over the past year,” Governor Tiff Macklem said in his opening remarks. “That puts us on a stronger footing as we face new challenges. But uncertainty about the sustainability of the rebound has increased with new US trade actions.”
The ongoing conflict in the Middle East also threatens to keep energy prices high for longer than expected, which increases the upside risks to the inflation outlook. In this context, the BoC reaffirmed its commitment to keeping inflation close to the 2% target over time: “We will be a source of stability as Canadians navigate shifting global developments.”
Below are some observations made by the Bank of Canada following its decision on September 2:
- Gross domestic product (GDP) increased by 3.3% in the second quarter.
- The unemployment rate fell slightly in July, standing at 6.4 percent.
- Inflation, as measured by the Consumer Price Index (CPI), has remained around 3% in recent months.
- Excluding the price of gas, inflation in Canada stood at 2.2% in July.
- Measures of core inflation remained close to 2 percent.
Our Observations
Clear Signals From the BoC
Regardless of the analytical angle chosen, the Canadian economy shows clear signs of strength. Consumption growth has averaged 2.4% over the past five quarters, far above productivity growth, and the gap between domestic demand growth and real GDP has stayed positive. Yet the BoC continues to say the economy is in excess supply. This is less plausible, especially after its 2024 and 2025 assumptions on the two potential growth drivers. The Bank first overestimated the growth of total hours worked, then assumed an uptrend in productivity that did not materialize. Since the output gap starting point strongly influences the endpoint, using potential-growth assumptions that missed the data two years in a row makes little sense.
Looking at Canada versus the US reinforces the message. In Canada, domestic demand growth has persistently exceeded productivity growth over the past five quarters, while the opposite has happened in the US. Historically, Canada has seen this kind of gap when oil prices surged and created a positive terms-of-trade shock. But post-Covid, the situation is different: the gap mostly reflects poor productivity growth. This suggests the Canadian economy is not in excess supply, meaning the cyclical factor cannot offset the other inflationary forces at play.
The Bank of Canada also relied on year-over-year (y/y) core CPI, which appears more favourable due to its significant difference from y/y total CPI. However, current y/y core CPI says nothing about upcoming core CPI. The 3-month annualized measure is already at 3.3%, and the BoC did not mention it, even though it used this same measure when inflation was moving down. Inflation in services excluding shelter tells the same story. The BoC highlighted it in the July Monetary Policy Report when it looked tame, but that was mostly due to temporary base effects. Since then, three very large monthly figures have pushed the y/y rate close to 4.0%.
There is no doubt the Canadian labour market remains inflationary. Since Covid, labour-cost-driven inflation components have stayed well above 2.0%, and the current measure is above 4.0%. In that context, low BoC median and trimmed-mean measures can be misleading because they exclude the true inflationary pressures linked to labour costs. This is the opposite of the US, where trimmed-mean measures make more sense because the wage-costs push component is nonexistent.
Using the Canadian National Accounts equivalent of the US PCE measure, inflation remains too high. The services inflation bill is still around $40B, about four times the pre-Covid level, while non-durable goods inflation is rising because of oil. The BoC can justify higher inflation risks from oil, but ignoring the persistent services inflation bill misses the point: services inflation is fundamental inflation and has lasted since 2022.
Lastly, our simulation points to serious upcoming core reflation in Canada, with core and total inflation converging by the end of Q1 2027. The BoC clearly laid the groundwork for interest rate hikes on Wednesday morning. The references to global resilience, broad-based real activity, solid consumption gains, and increased upside risks to inflation were hawkish signals. The bond market noticed, with the Canadian curve flattening as Governor Macklem spoke.