The Bank of Canada is holding its policy rate at 2.25 per cent and says that it expects the Canadian economy to improve, despite flatlined growth over the past 18 months.
But there are big caveats. Although the economy is showing signs of improvement and inflation is easing, the BOC’s new monetary policy report released today warns that uncertainty driven by U.S. tariffs and the war in the Middle East could knock potential growth off course.
The BOC report indicates that the level of gross domestic product was “roughly unchanged from the first quarter of 2025 to the first quarter of 2026.”
GDP growth was close to zero, weaker than the 1.5 per cent growth the central bank projected in April.
The BOC says that there was a “rebound” in the second quarter between April and June, which saw a pickup in exports and residential investment. As a result, the central bank estimates the economy will grow just above one per cent in the first half of 2026.
Growth was dragged down last quarter by several temporary factors.
According to the report, this included an unexpected decline in government spending, a fall in motor vehicle production and a sudden drop in oil and gas investment.
Housing activity also dropped in the first quarter “hampered by affordability challenges, slow population growth and elevated economic uncertainty.”
However, consumer spending “remained resilient” last quarter despite elevated uncertainty and higher gas prices.
Earlier in July, the Bank’s business outlook survey indicated that overall business sentiment was deteriorating amid the war between the U.S and Iran.
The Canada-U.S.-Mexico trade agreement is under review and business investment remains flat.
But Bank of Canada Governor Tiff Macklem said that when you dig down into “subcomponents” the data indicates the economy is improving.
In a news conference, Macklem pointed out that the private sector is adapting to the uncertain trade relationship with the United States.
“(Companies) are finding ways to work with their clients. They’re reconfiguring their supply chains and they’re getting on with business,” Macklem said, adding the strong American economy and low Canadian dollar are contributing to more orders for Canadian exports.
“If you get more exports, ... you’ll probably get more business investment.”
The head of the central bank also credits Canadian consumers for propping up the economy, even though there’s currently little population growth.
“They’ve been resilient. Consumer spending is still expanding. … There are not new consumers entering the economy, but Canadian households are still spending.”
Inflation risks
The outcome of Canada’s trade relationship with the United States and the war in the Middle East remain the two biggest risks which could drive up the cost of living.
Headline inflation has risen above three per cent but could come down if oil prices and gasoline refinery margins decline.
The report’s projection was finalized before a ceasefire between the U.S. and Iran broke down on the weekend. About 20 per cent of the world’s oil transits through the Strait of Hormuz and commercial traffic through the waterway has once again slowed to a trickle.
Inflation, excluding gasoline, remains near two per cent.
The unemployment rate has generally fluctuated between 6.5 per cent and seven per cent, which the BOC says points to excess supply in the economy.
