Macklem’s Opportunity to Lead

Markets are broadly assuming that the Bank of Canada will hold steady on June 4 and delay its next rate cut until July. That timeline might be too cautious. While Governor Macklem struck a slightly hawkish tone in interviews after the Banff G7 Summit, the downside risks to growth and the shifting inflation landscape may warrant more nimble action. We discuss reasons behind our view that the BoC will resume rate cuts next week.

First, the recent jump in core inflation looks more benign than at first sight. April’s CPI release was the catalyst leading markets to stop pricing in a June cut, given the meaningful uptick in the BoC’s preferred core inflation measures. But most of the acceleration came from a narrow set of components: rents (after several months of weakness) and airfares, which are notoriously volatile and seasonally erratic. We don’t suspect these shifts mark an inflection to sustained price momentum in these categories. Goods affected by Canada’s retaliatory tariffs also showed increases in prices, although these effects could be fleeting. More on that later. The carbon tax repeal may also have played a role if utility providers offset the tax cut by raising their prices, as some evidence suggests. Since core inflation measures exclude indirect taxes, they would capture the implicit price increase but not the corresponding tax relief. Yet for consumers, and ultimately for inflation expectations, both matter. As a result, this technical quirk is unlikely to sway expectations meaningfully. What that means, ironically, is that the Bank of Canada should probably disregard the noise currently affecting its core CPI measures.

Second, a stronger Canadian dollar gives the BoC more room to tilt towards supporting growth. The loonie is up by a bit over 3% year to date, and we expect it to appreciate a bit further in the second half of the year. This should somewhat help mitigate the inflationary effects of countervailing tariffs, although it comes at the expense of added drag on exports. To the extent that markets are not positioned for a cut next week, cutting in June could take some steam out of the loonie and offer a modest reprieve to exporters without materially altering the inflation path.

Third, there is room for cautious optimism on the inflationary outlook for retaliatory tariffs. With CUSMA carve-outs keeping Canada’s effective tariff rate low, the Carney government has less incentive to escalate with aggressive countermeasures. So far, Ottawa has imposed tariffs on roughly $60B worth of US goods and mirrored Washington’s vehicle tariff approach. However, a portion of those measures has already been put on a six-month pause to avoid disrupting supply chains. While future trade policy decisions affecting Canada remain hard to predict, the tone between Ottawa and Washington has grown more conciliatory in recent weeks. The legal obstacles that Trump’s trade policy encountered this week could perhaps also help pave the way for a deal. As a result, the likelihood that Canada proceeds with tariffs on the full $185B list floated earlier this year has diminished.

Fourth, while tail risks to growth and inflation have eased, Canada’s economy is hardly in the clear. Two of its largest housing markets are weakening, with rising listings and mounting price pressures. Population growth, a key support over the past two years, is fading as temporary resident policies tighten. For financially vulnerable households, particularly those with variable-rate mortgages, renewals at higher rates are becoming increasingly burdensome. Meanwhile, several provincial governments have signalled plans to significantly slow per capita operating spending growth in response to mounting fiscal pressures. These forces combined are already weighing on consumption, which barely advanced on a per capita basis in Q1, and housing activity. Business investment, which is typically the first casualty in periods of heightened uncertainty, will likely pull back after being artificially propped up by tariff front-running in Q1. Job losses are accumulating in manufacturing, and hiring appetite is softening in other sectors. We continue to expect that a mild Canadian recession has begun this quarter, reinforcing the case for policy action to ease the pressures facing trade-exposed and rate-sensitive segments of the economy.

Fifth, the Bank of Canada still has room to cut. With the neutral rate estimated to be between 2.25% and 3.25%, a 25bp reduction next week would still leave the policy rate within neutral territory. The move would be justified on a balance of risks that has shifted incrementally away from fast accelerating inflation and towards weakening growth. We ultimately expect the Bank to bring the overnight rate to 2.00% this year.

So where could we go wrong next Wednesday? The classic counterargument contends that waiting until July would provide the Bank with more data. But this is the apology of hesitancy. Indecisiveness comes at the expense of responsiveness. A June cut, by contrast, would allow the Bank to get ahead of a downturn at a time when upside tail inflation risks have diminished. In other words, if Macklem still takes the lags of monetary policy seriously, this is the moment for him to take the lead.