Bank of Canada Holds at 2.25% as Traders Price 50-50 Hike Odds

The Bank of Canada kept rates at 2.25% for a seventh straight decision, yet Governor Tiff Macklem's hawkish tone on inflation pushed two-year yields above 3.1% as markets priced a 50-50 chance of a hike.

"Central bank officials view inflation as a greater threat to the central bank's price stability mandate than trade disruption, making it inappropriate to consider easing policy at this juncture," Karl Schamotta, chief market strategist at global-payments firm Corpay, said.

Macklem said the central bank is prepared to raise rates to cool inflation, and prepared to do so more than once if necessary. The yield on a two-year Canada government bond climbed above 3.1% during the press conference from about 3.02% before the decision, while the Canadian dollar strengthened. Inflation stands at roughly 3 percent, above the bank's 2 percent target, and could move higher as crude-oil prices remain elevated after the Middle East conflict curtailed shipments through the Strait of Hormuz.

The hawkish pivot complicates the Bank of Canada's path as fresh U.S. tariffs of 50 percent on certain Canadian goods and retaliatory duties threaten to slow growth in the fourth quarter. The central bank is set to issue an updated forecast next month alongside its rate decision.

The shift in tone caught economists off guard. All analysts surveyed by The Wall Street Journal last week predicted the bank would hold and emphasize downside growth risks from the trade escalation. Instead, Macklem devoted much of his press conference to the inflation outlook, warning that "the situation in the Middle East is no closer to resolution, and the longer it goes, bigger is the chance that feeds through to higher prices for non-energy goods."

The hawkish stance aligns Canada with a broader global tightening bias. The European Central Bank is widely expected to raise its deposit rate by 25 basis points to 2.50% at its Sept. 10 meeting, with markets pricing a probability above 95 percent, according to Bundesbank President Joachim Nagel. In the United States, futures markets assign a 66 percent chance the Federal Reserve raises its benchmark rate at the Sept. 15-16 meeting, per CME FedWatch data. Brent crude settled at $94.65 a barrel Tuesday, up 4.6 percent, after renewed U.S.-Iran strikes shut down the Strait of Hormuz, through which about 20 percent of global oil typically flows.

Trade conflict adds a second headwind

Macklem acknowledged that the sharp deterioration in U.S.-Canada commercial ties poses challenges and risks stifling a nascent recovery that suggested businesses were learning to live with heightened trade-policy uncertainty. Fresh U.S. tariffs of 50 percent on certain Canadian goods, combined with retaliatory duties from Canada, could increase costs to consumers and drag on growth in the fourth quarter, he said.

Yet the governor said the new tariffs are expected to hit certain sectors hard but not have "a large direct impact on the overall level of economic activity." He pointed to second-quarter data showing the economy grew 3.3 percent annualized, exceeding the bank's forecast of 2.5 percent, with growth broad-based across exports, household consumption and business investment.

"We would be wary of pencilling in any policy tightening just yet," said Nick Rees, head of macro research at Monex Canada, a foreign-exchange and payments firm. He noted that U.S.-Canada trade tensions have upended the growth outlook, while the central bank said labor demand remains subdued and indicators point to excess capacity in the economy.

The global bond selloff that has pushed U.S. 30-year yields above 5 percent on 55 trading days this year — the most since 2006 — compounds the pressure on the Bank of Canada. Rising long-term borrowing costs in global financial markets complicate the central bank's task as investors demand higher returns while persistent uncertainty keeps inflation expectations elevated.

The central bank's next rate decision and updated forecast arrive in October. If inflation continues to run near 3 percent and oil prices stay elevated, the 50-50 odds of a hike before year-end could shift decisively toward action. If trade disruptions instead bite harder into growth, the bank may face a stagflationary trade-off that no single rate move can resolve.

This article is for informational purposes only and does not constitute investment advice.