By Promit Mukherjee and David Ljunggren
OTTAWA, March 18 (Reuters) – The Bank of Canada on Wednesday kept its key policy rate on hold, as expected, but Governor Tiff Macklem warned it was ready to raise borrowing costs if higher energy prices risked turning into persistent inflation.
The bank, which has kept its key rate at 2.25% since October, said the Middle East conflict would drive up gasoline prices and boost inflation in the short term.
Macklem said it was too early to assess the effect of the war, saying the risk of higher energy costs quickly spilling into broader prices looked contained.
“Governing Council will look through the war’s immediate impact on inflation but if energy prices stay high, we will not let their effects broaden and become persistent inflation,” he said in opening remarks.
Pressed later by reporters as to how long the bank would look through the effect of higher energy prices, he said, “I don’t think you measure this in weeks … We have got some time to make that assessment,” he said.
The BoC’s next policy decision is on April 29 and markets are pricing in a hold once again.
MARKETS ADD TO RATE HIKE BETS
Before the conflict, inflation had hovered near the bank’s 2% target for almost a year, with policy seen as modestly supporting a weak economy.
“We can raise the policy interest rate to cool inflation,” said Macklem, adding that the bank could cut rates if energy prices came down and the economy weakened further.
Economists say persistently high energy prices could upend forecasts for growth and inflation if the Strait of Hormuz – which handles a fifth of global oil trade – remains shut for more than a few weeks.
“The tone of these communications reinforces our view that the Bank of Canada is willing to look through the impacts of higher energy prices on CPI so long as the conflict doesn’t last for too long,” Royce Mendes, managing director at Desjardins, wrote in a note.
“As a result, we continue to expect officials will leave the policy rate unchanged for the duration of this year,” he said.
Money markets, which had priced in a likely December hike, increased their bets for an increase from June onwards, with expectations for a full 25-basis-point move in December rising sharply.
The Canadian dollar weakened after the announcement, slipping 0.04% to C$1.3696 or 73.01 U.S. cents.
“Economic weakness combined with rising inflation is a dilemma for central banks,” said Macklem.
“Raising interest rates to slow inflation could further weaken the economy. Easing interest rates to support growth risks pushing inflation well above target.”
He said near-term growth was likely to be weaker than the bank projected in January and described uncertainty as acute.
Canada is also contending with U.S. tariffs on some critical sectors, subdued business investment, a soft labor market and uncertainty over the future of the U.S.-Mexico-Canada trade deal.
(Reporting by Promit Mukherjee and David Ljunggren; Editing by Mark Potter and Nick Zieminski)
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