Inflation holds the key to BoC's September rate decision

The Bank of Canada (BoC) faces a pivotal decision this week as new inflation figures are set to determine whether policymakers move ahead with an anticipated rate cut. Markets are pricing in a 90% chance of a reduction when the central bank meets Wednesday, but economists caution that the August consumer price index (CPI), released Tuesday, could be decisive.

Weak economy strengthens case for easing

Canada’s economy has shown clear signs of strain in recent months. Gross domestic product contracted by 1.6% in the second quarter, exceeding expectations of a smaller decline. The labour market also weakened sharply, with 100,000 jobs lost over July and August, pushing the unemployment rate to 7.1%, the highest level outside of the pandemic in nearly a decade.

“I think they have a very strong case to cut interest rates,” said Jimmy Jean, chief economist at Desjardins Group, in an interview with Yahoo! Finance. He noted that soft economic growth and labour market deterioration both point toward easing policy.

The BoC has kept its benchmark rate at 2.75% over its last three meetings, holding steady in the face of trade tensions with the United States and lingering inflationary pressures.

Inflation remains the swing factor

While headline inflation dipped below 2% in July, core inflation measures remain closer to 3%, the top end of the BoC’s target range, with the August figures due for release on Tuesday morning (Septeber 16). RBC economists Nathan Janzen and Claire Fan said the central bank’s decision will likely “narrowly opt for a hold,” depending heavily on whether Tuesday’s inflation data confirms easing price growth.

The August CPI is expected to rise to 2.1% from 1.7% in July, largely reflecting base effects and the earlier removal of carbon taxes on gasoline. Excluding food and energy, inflation may climb to 2.8%, with the BoC’s median and trim core measures holding near 3%.

Governor Tiff Macklem signalled in July that further cuts would be possible if weakening demand continued to put downward pressure on prices. “If a weakening economy puts further downward pressure on inflation and the upward price pressures from trade disruptions are contained, there may be a need for a reduction in the policy interest rate,” he said at the time.

Policy trade-offs remain complex

Despite clear signs of economic stress, some analysts caution that broad-based rate cuts risk fuelling demand in sectors that remain resilient, including housing. RBC noted that consumer spending rose in the second quarter and housing markets are stabilizing, suggesting fiscal policy may be better suited than monetary easing to provide targeted support.

CMP

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