Monetary Status Quo on Both Sides of the Border

North American central banks announced their respective decisions regarding the policy rate on Wednesday. As expected, the Bank of Canada (BoC) kept its rate at 2.25% for the fourth consecutive time, while the US Federal Reserve (Fed) maintained its target range of 3.50% to 3.75%. 

Conservative Core Inflation Forecasts in Canada 

In the press release issued following its decision, the Bank of Canada cited the uncertainty stemming from the conflict in the Middle East and US trade policy. The Governing Council emphasizes that it remains ready to act, noting that it “is looking through the war’s immediate impact on inflation but will not let higher energy prices become persistent inflation.” 

In his opening remarks, Governor Tiff Macklem stated that the Bank of Canada will need to remain flexible in order to address significant geopolitical uncertainties. “If the United States imposes significant new trade restrictions on Canada, we may need to cut the policy rate further to support economic growth. Alternatively, if oil prices continue to increase, and particularly if they remain elevated, the risk that higher energy prices become ongoing generalized inflation increases,” he explained.  

The decision announced on Wednesday was made in conjunction with the publication of the April Monetary Policy Report (MPR). Here are a few highlights: 

• The economy continues to adjust to structural changes. 

• The GDP growth forecast for 2026 has been revised upwards, from 1.1% in January to 1.2%. 

• The projected inflation rate has been raised to 2.3% for 2026, an increase of 0.3 basis points. 

• Core inflation is expected to remain around 2% throughout the projection period. 

• The BoC sees little evidence of spillover effects yet and is currently looking through the shock. 

Our Observations 
 
The Bank of Canada spent most of the press briefing discussing the risks of rising inflation, rather than the risk that the renegotiation of the Canada-United States-Mexico Free Trade Agreement (USMCA) could pose to growth. Two days ago, the forecast for the central bank’s interest rate in December stood at 2.62%. By 10:30 a.m., it had climbed to 2.81%, before rising further at 10:45 a.m., when Governor Macklem explicitly stated that “consecutive rate increases may be necessary.” 
 
First, it should be noted that the complete reversal of the inflationary trend forecast by the Bank of Canada seems a bit premature, given that it expects oil prices to return to $75 only by the middle of next year. Our calculations do not suggest such a rapid reversal of the trend, as the dynamics of oil prices are considered too persistent to allow for a return to price stability as quickly as projected in the Monetary Policy Report. 
 
It should also be noted that significant fluctuations in overall inflation, as measured by the consumer price index (CPI), are expected in Canada. As a matter of fact, very specific factors, such as the end of the carbon tax rebate, will be followed by the suspension of the gas tax decided by Mark Carney (a measure that will take effect in May and be announced in June). The uptrend remains intact, however, due to pressure in services excluding shelter, assuming that wage growth remains between 3.0% and 3.5%.  

Lastly, when using services inflation as measured by the Personal Consumption Expenditures (PCE) price index rather than the CPI, it is clear that Canada has consistently failed to meet its price stability target in the wake of the COVID-19 pandemic. With inflation in services, as measured by the PCE index, consistently running above the price-stability target, Canada still has a lot of work to do. The Bank of Canada’s decision to lower its policy rate to the lowest level within the neutral range, despite weak productivity growth, makes its current stance highly risky in the context of an oil price shock. 
 
Surprising Dissenting Voices Within the Fed 

The US Federal Reserve justified its decision by citing high inflation, due in part to the recent rise in global energy prices. In its statement, the central bank thus departed from its previous wording, which described inflation as merely “somewhat” high. 

The monetary policy announcement drew dissent from three members, who now believe that the US central bank should no longer signal its intention to cut interest rates. A fourth dissenting vote expressed at the meeting called for a rate cut of a quarter of a percentage point.  

This sharp opposition underscores the extent of the differences of opinion that the next Fed chair, Kevin Warsh, will face in his efforts to secure rate cuts, in line with the expectations expressed by Donald Trump. 
The announcement of the Fed’s decision was not accompanied by an update of its economic forecasts.  

Our observations 

The Fed’s press release began with a slight change regarding the US labour market. Instead of stating that “job gains remained low,” the FOMC added the words “on average.” The reason is simple: employment figures have recently been extremely volatile, fluctuating between growth territory and job losses. That said, the latest figures have exceeded all expectations. Furthermore, recent weekly ADP reports from the private sector have shown a marked improvement in the US labour market, suggesting that April’s employment figures could be around 150,000 new jobs. While we acknowledge that this indicator does not have a perfect track record, completely ignoring this new information, i.e., jumping from 0 to 40,000 per week, would undermine our own analysis. Therefore, we have factored in an upside risk to the US labour market in our baseline scenario. 

The price of oil is currently a major unknown, especially since it has rebounded above $100 a barrel as the Strait of Hormuz remains closed. This situation could change at any time. That is why Chairman Powell said today that central banks would be better off ignoring this oil shock. If the trend were to reverse quickly and the Fed were to respond by raising its policy rate, it would likely have to lower it again within a quarter.  

Given the gap between rates and inflation, this would not be responsible monetary policy. The sole exception applies when inflation expectations are unanchored. This leads to faster wage growth to keep pace with the higher inflation rate caused by rising oil prices. On this point, Mr. Powell reiterated that the Fed’s credibility remained high in the financial markets. Two-year inflation expectations have risen, but 10-year expectations have remained moderate. In this context, the views expressed by the three dissidents today were somewhat surprising. 

In fact, we believe it is premature to take a different stance in the current context due to an oil shock. First, never in the Fed’s history of inflation targeting has the composition of real private-sector GDP growth been dominated by such a significant supply-side shock, namely productivity, during an expansionary phase of the cycle. While productivity-driven growth following a recession is a clear cyclical fact, this has never occurred during an expansion. Moreover, this dynamic has been underway for two years now. It is therefore unusual to express a dissenting view in such a supply-driven economy, because in this kind of environment, as soon as oil prices fall, both total inflation and core inflation tend to follow suit.