The Bank of Canada has kept its policy rate at 2.75%. This decision comes amid uncertainties in U.S. trade, strong Canadian economic performance, and rising inflation. Instead of providing a traditional forecast in July’s Monetary Policy Report, the Bank presented three scenarios related to tariffs: current levels, escalation, and de-escalation.

Canada’s Economic Performance

While global growth appears steady, Canada’s momentum has slowed down. In Q1 2025, growth was strong as companies rushed to export goods before potential tariff changes. However, Q2 likely faced a 1.5% contraction due to a drop in exports to the U.S. and reduced demand, which affected spending. Job losses in trade-related sectors added to the challenge. On the bright side, job growth continues in other sectors, and both business and consumer confidence are showing slight improvement. The Consumer Price Index (CPI) inflation is just under 2%, mainly due to the removal of the carbon tax, though core inflation has risen to around 2.5%. This increase mostly comes from non-energy goods, while shelter costs remain high but are starting to decrease. Although business inflation expectations have softened, consumer expectations remain elevated. The Bank predicts inflation will stabilize around 2%, with risks balanced. Governor Macklem indicated that the Bank is keeping a close watch on economic data and may change policy if necessary. While the policy rate holds steady, a cut could happen if economic conditions worsen, as long as inflation pressures are managed to maintain price stability amid global uncertainties. The Bank’s choice to keep rates steady while hinting at a dovish stance suggests we should anticipate a potential rate cut. The July 2025 jobs report showed unemployment rising to 7.1%, while Statistics Canada’s latest CPI data revealed a dip in headline inflation to 1.7%. This supports the argument for a more lenient policy. Traders might consider buying call options on Bankers’ Acceptance (BAX) futures, which could yield profits if short-term interest rates drop in the coming months.

Market Implications and Predictions

Given the Bank’s three-scenario approach tied to U.S. trade outcomes, we can expect considerable volatility in the Canadian dollar. Implied volatility for USD/CAD options has already surged to 8.5%, reflecting the uncertainty surrounding upcoming trade talks and the August GDP report. This situation suggests that investing in option straddles or strangles could be beneficial, allowing traders to profit from large price swings regardless of the final policy decision. That said, a rate cut isn’t assured, and the market may be overly optimistic. Overnight index swaps currently show nearly an 80% chance of a 25-basis-point cut by the September meeting, meaning a decision to maintain rates could lead to a sharp market reaction. The Bank is also concerned about core inflation, which remains high at 2.3%, justifying a cautious stance as it waits for more data before making any moves. This environment mirrors the uncertainty seen in late 2024 when initial tariff threats caused a temporary spike in rate volatility. Therefore, traders should closely monitor forthcoming Canadian retail sales data and statements from U.S. trade representatives. These developments will be crucial in influencing the Bank’s next steps and market trends. Create your live VT Markets account and start trading now.

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