Canada's economy softens further – but BoC still faces big dilemma on rate cuts

Canada’s economy contracted slightly in April, spurred mainly by the biggest manufacturing-sector decline for four years – but this week’s sticky inflation figures mean the Bank of Canada may not have the green light to cut interest rates yet.

Statistics Canada said on Friday that real gross domestic product for April slipped by 0.1%, lower than its advance expectations, with a preliminary estimate for May also suggesting a decline by the same amount that month.

The manufacturing sector slowed by 1.9%, its largest drop since April 2021, as the economy’s sluggish performance amid a bruising trade war with the United States continued.

Still, Bank of Montreal (BMO) chief economist Doug Porter suggested that while that weakness is unsurprising, the central bank will be making no snap decisions based on the April data.

“We suspect that the underlying softness in growth and employment will eventually pave the way for additional rate relief,” he said in a note to clients. “However, the stickiness of core inflation remains a big hurdle for near-term rate cuts; we still have exactly one month of data before the next decision.”

The overall inflation rate held steady at 1.7% in May, StatCan said on Tuesday, but the core consumer price index (CPI) – which excludes volatile food and energy costs – remained elevated at 3.0% despite easing slightly month over month.

Central bank still in wait-and-see mode despite economic slowdown

Canadian Imperial Bank of Commerce (CIBC) economist Andrew Grantham said the latest economic data was “somewhat supportive” of the bank’s expectations that a rate cut is on the way at the end of July, although he added that’s by no means a surefire thing.

“Upcoming employment and inflation data will be more important in determining whether policymakers feel comfortable making a move at that time,” Grantham said.

Expectations of a slight contraction in the second quarter mean the economy’s performance is likely to fall somewhere between the two scenarios mapped out by the Bank of Canada in an April monetary policy report – one envisaging huge turbulence from the trade war, and another with a more optimistic bent.

Porter said BMO’s expectations for the second and third quarters are “certainly not good news, but also a less dire outcome than expected a few months back at the height of the tariff drama.”

Much will depend on whether negotiations progress between Canada and the US on ending the trade war, with prime minister Mark Carney and US president Donald Trump working to strike a deal by July 21.

LSEG data suggests financial markets view a 37% chance that the Bank of Canada will decide to trim its benchmark rate in July, with higher expectations of rate cuts further down the line in 2025.

CMP

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