Canada Economics Weekly: Risks shift more dovish since June policy ‘dilemma‘

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Canada Economics Weekly: Risks shift more dovish since June policy ‘dilemma‘

h softer Q1 GDP and downward revisions to Q4 last

year, the level of GDP is still likely to be lower by mid-year than expected in April

even with a strong Q2 rebound. By our estimates, this could lead to a ~20bp wider

output gap than assumed in April (though the wide range estimated for the output

gap of -0.5% to -1.5% could remain the same).

Given reduced inflation risks and an even wider output gap, we expect guidance on

possible adjustments to policy rates to take another more dovish step in July.

Opening remarks from Governor Macklem will likely reiterate risks that policy rates

may need to rise if upside inflation risks materialize or may need to fall if there are

new trade escalations. But we also expect remarks to explicitly mention a new

scenario where subdued core inflation allows for slightly lower rates to help

support demand and close the output gap.

For officials to move rates as soon as September (our base case) there likely needs

to be an even more explicit indication of these risks in the guidance in the policy

statement. We could imagine something along the lines of:

Against this overall backdrop, Governing Council decided to maintain the policy

rate at 2.25%. Economic activity in Canada has been weaker than expected in April

forecasts, and uncertainty about US trade policy and the conflict in the Middle East

persists. Upside risks to inflation from higher energy prices remain, but an economy

in greater excess supply is acting to put downward pressure on inflation. As the

outlook evolves, slight adjustments to the policy rate may be appropriate. The Bank

is committed to maintaining Canadians’ confidence in price stability through this

period of global upheaval.