What will the Bank of Canada do at its next interest rate announcement? Probably nothing — and that will come as no surprise to financial markets.
After peaking at five per cent in mid-2023 — the highest level in 22 years — the Bank of Canada’s key interest rate has gradually fallen and has remained at 2.25 per cent since October 2025. The bank’s next rate decision is scheduled for June 10, and most economists expect policymakers to leave the benchmark rate unchanged.
That expectation reflects recent inflation data. Inflation rose to 2.8 per cent in April from 2.4 per cent in March, but the increase was smaller than anticipated. Analysts surveyed by Reuters had forecast inflation would reach 3.1 per cent, above the bank’s own projection of three per cent.
As a result, most economists expect the bank to leave its benchmark interest rate unchanged next month.
Keeping rates steady would likely be the right decision.
The recent rise in inflation was not caused by stronger demand or rising wages. It was driven largely by geopolitical tensions and the war with Iran — a temporary supply shock that could ease once the conflict subsides.
In fact, much of the increase in inflation came from a 28 per cent jump in gasoline prices. Excluding gasoline, inflation would have been just 1.8 per cent.
Right now, holding rates steady would be the safe line of action. It would allow the bank to avoid criticism while giving inflationary pressures more time to cool on their own.
Still, if inflation remains above the Bank of Canada’s two per cent target for an extended period, how long can the bank resist pressure to raise rates again?
Financial markets are already signalling expectations of higher rates — not because higher borrowing costs would solve the current inflation problem, but because central banks often feel compelled to act to preserve their credibility.
Since the start of the war with Iran, the yield on five-year government of Canada bonds has climbed 68 basis points, reaching 3.35 per cent on May 19 — the highest level in two years.
After the bank’s April rate decision, governor Tiff Macklem warned “there may be a need for consecutive increases in the policy rate” if higher oil prices begin feeding broader inflation.
That means rate hikes later this year cannot be ruled out, especially if oil prices remain elevated and headline inflation stays high.
For the Bank of Canada, raising rates would likely be the path of least resistance because it would align with market expectations. And with the overnight rate still relatively low at 2.25 per cent, one or two quarter-point increases would probably have little effect on inflation or unemployment anyway.
If inflation later falls as oil prices stabilize, the bank will likely claim success once again: inflation reduced without triggering a recession.
But that interpretation deserves more scrutiny.
Central banks have limited tools to deal with inflation caused by supply shocks such as wars or spikes in energy prices. Their main tool — higher interest rates — works by slowing the economy. If supply-driven inflation persists, that often means higher unemployment and recession.
The deep recessions of the early 1980s and 1990s should serve as reminders of the risks of relying too heavily on interest rate hikes to fight inflation.
Higher rates also have distributional consequences that are often overlooked. They tend to reward creditors, while shifting the burden of adjustment onto workers, mortgage holders and heavily indebted households.
In short, today’s inflation is not primarily a problem the Bank of Canada can solve on its own — just as the post-pandemic inflation surge was not.
This is ultimately a political and economic challenge for the federal government, especially in an energy superpower such as Canada.
Yet governments often prefer to leave the burden to central banks rather than confront the corporations and industries that shape prices, control key resources and generate outsized profits during periods of inflation.
