Governor Tiff Macklem at the Bank of Canada warned that interest rates may need to rise if the war in Iran leads to persistent inflation in Canada.
Inflation has jumped above three per cent in recent months as higher oil prices from the Iran war sent gasoline costs skyrocketing over the spring.
The Bank of Canada left interest rates unchanged at 2.25 per cent Wednesday, in its fifth monetary policy decision of the year.
After the announcement, Macklem said that although the war has caused consumer gasoline to get more expensive, prices for most other goods and services have remained relatively stable so far.
But that could change the longer the conflict goes on.
“War-related cost pressures are still working their way through some consumer prices,” said Macklem.
“We’ve been looking through the direct effects of higher oil prices on inflation, but the longer they remain elevated, the bigger the risk they spill over to other goods and services.”
“We will not let higher oil prices become persistent inflation.”
Central banks like the Bank of Canada use economic levers to maintain price stability while also encouraging growth. Adjusting monetary policy, or the benchmark lending rate for consumers and businesses, is the main lever used to reach this delicate balance.
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Will interest rates rise, fall or stay the same? What to expect from the Bank of Canada’s June interest rate decision
The Bank of Canada updates monetary policy several times throughout the year based on economic reports on GDP, the job market and inflation, among others.
Economists widely expected the central bank to remain on hold this month.
“The Bank of Canada’s decision to leave its policy rate unchanged comes as little surprise,” says CPA Canada’s chief economist David-Alexandre Brassard in a statement.
“A few months ago, recession concerns dominated the conversation. With core inflation now very close to target and economic conditions improving, there is little reason for the bank to intervene.”
In other words, Canada’s economy has shown signs that it may not need any changes in interest rates in the near future, but the bank says it’s basing its forecast on the expectation that oil prices will eventually come down.
Macklem says “there are risks” if oil prices stay elevated for the long-term, which may result in higher interest rates.
“If that happens, we may well need to raise interest rates. That’s not our base case, but it is a serious risk.”
In prepared statements, Macklem said Canada’s economy has been impacted by tariffs and trade tensions with the United States, which resulted in what he called “choppy” GDP data.
“Canada’s GDP data over the past year was choppy and growth stalled as the economy adjusted to new tariffs, high uncertainty and slower population growth,” he said.
Although it is unlikely the central bank will make any changes to interest rates anytime soon, Macklem underscored the bank’s readiness to “adjust monetary policy as needed.”
Canada’s economy slipped into a technical recession in the first quarter of the year after annualized GDP fell modestly for two straight quarters.
This sparked debate among economists and policymakers as to whether the recession label should be taken at face value, considering several other key areas of the economy were otherwise stable or expected to grow.
GDP bounced back in April, the national unemployment rate declined to 6.5 per cent in June and the same month’s inflation report showed core consumer price growth was heading in the right direction despite higher gas prices.
“There are clear signs that economic growth has resumed in the second quarter,” said Macklem.
“While this largely reflects the unwinding of temporary factors, sources of economic growth appear to be broadening.”
– with files from The Canadian Press
Based on reporting by Global News.