Bank of Canada mulls Trump tariff shock as it holds interest rates

The Bank of Canada has held interest rates, amid the prospect of weaker growth and higher inflation, thanks to the retaliatory tariff blitz that followed the collapse of U.S. trade negotiations.

The central bank decided to hold its key rate at 2.25% at its September meeting, it announced Wednesday, despite citing elevated energy prices resulting from the ongoing conflict in the Middle East.

"The upside risks to inflation have increased, while new tariffs make growth prospects more uncertain," the BoC said in a statement.

Further U.S. tariffs could jeopardize the sustainability of Canada's economic recovery, it added.

U.S. President Donald Trump's new duties against the U.S.' second-biggest trading partner include 50% tariffs on a wide range of Canadian goods. Canada has announced retaliatory tariffs, due to take effect on Sept. 8 and impact more than $20 billion in goods.

The BoC is expected to hike rates over the next 12 months.

The BoC decision was the seventh consecutive decision to hold the rate, which is down from a recent peak of 5%. The Canadian economy grew by 0.8% in the second quarter, strengthening from 0.1% in the first three months of the year.

"The BoC is in a wait-and-see mode, but that doesn't mean it's standing still", Michael Constantino, CEO of WeBull Canada, said in a note after the decision.

He added the bank's governor, Tiff Macklem, was "threading a difficult needle, with inflation running above target on energy price volatility even as fresh U.S. tariffs threaten to slow a second-quarter economy that grew at its fastest pace in three years."

Constantino called the hold "a deliberate pause for information." "The next real test will come as the effects of retaliatory tariffs and elevated crude prices begin to show up more clearly in the economy," he added.

The most recent figures show headline consumer inflation accelerated to 3% year-on-year in July, up from 2.8% in June, prompting traders to price three BoC rate hikes over the coming 12 months. But BoA expects the BoC to keep rates on hold over the coming months.

"Trade uncertainty has risen as the trade war with the US has just escalated, which will likely weigh on growth, and core inflation is at the 2% target. We expect only a direct impact from tariffs on inflation, without second-round effects," Bank of America economist Carlos Capistran wrote in a Tuesday note.

"A firmer 2Q and above-target headline inflation argue for caution, but the escalation of the trade war with the US is the more consequential development for monetary policy, in our view," said Capistran.

Goldman Sachs forecasts a 0.3 percentage point headwind to GDP growth and 0.3 percentage point boost to inflation in Canada as a result of Trump's tariffs.

"These downside growth concerns and continued volatility in trade tensions will likely keep the BoC on hold for the foreseeable future," the bank wrote in an Aug. 28 note.