Bank of Canada governor takes questions after interest rate decision

Morning to everyone who's joining us. The senior deputy governor, Carolyn Rogers and I, are very pleased to be with you this morning to discuss our monetary policy report and our monetary policy decision. The Governing Council has maintained the policy interest rate at 2 and 1/4%. We have three key messages. First, after stalling over the past year, economic growth looks to have resumed in Canada. While US trade policy continues to be a headwind, consumers have been resilient and businesses are adapting. Second, inflation in Canada is poised to ease provided global oil prices decline from elevated levels. And third, uncertainty remains high. The conflict in the Middle East has re-escalated in recent days and trade discussions with the United States remain ongoing.

So, let me now expand on the outlook, the risks, and implications for monetary policy. Growth has been dented by the conflict and global growth has been dented by the conflict in the Middle East. But with oil prices coming partway back down, growth is expected to recover. Equity markets have been buoyant and credit spreads remain compressed. Canada's GDP growth was flat over the past year as the economy adjusted to new tariffs, elevated uncertainty, and slower population growth. The economy remains in excess supply. The labor market has been soft with the unemployment rate hovering in a range of 6 and 1/2 to 7%. GDP growth in the second quarter is estimated to have picked up to 2 and 1/2%. While this rebound from the first quarter largely reflects the unwinding of temporary factors, sources of economic growth appear to be broadening. Recent indicators point to continued solid consumer spending. Housing activity, which has been weak, looks to be stabilizing. Export growth has resumed and is expected to continue to strengthen, albeit along a lower path. Business investment is picking up, boosted in the near term by the oil and gas sector. And although the Canada-US-Mexico Agreement is now subject to annual reviews, more businesses report they are finding ways to navigate through this uncertainty. Government spending also contributes to higher economic activity over the projection. Overall, our growth outlook is similar to our April forecast, but the data we've received since April have increased our confidence that the economy is indeed working through this period of global upheaval.

Following GDP growth of 0.7% in 2026, the economy is projected to grow by 1.8% in both 2027 and 2028. As the recovery proceeds, economic slack will be gradually absorbed. CPI inflation rose to 3.2% in May, mainly because of the higher gasoline prices linked to the conflict in the Middle East. Excluding gasoline, inflation was 2.2% and measures of core inflation have remained close to 2%. So far, we're not seeing broad spillovers of energy prices to other goods and services. Near-term inflation expectations are sensitive to changes in gasoline prices, but longer-term inflation expectations remain well anchored. War-related cost pressures are still working their way through some consumer prices, but they're being offset by downward pressure from other prices from continued economic slack. In addition, the recent depreciation of the Canadian dollar will make our exports more competitive, but it also increases the costs of our imports. Inflation is expected to stay elevated in June and then ease gradually in the coming months, returning to the 2% target in early 2027.

I do want to underline that this forecast is highly dependent on the path for global oil prices and gasoline prices. It assumes oil prices come down and stabilize between 70 to 75 dollars US per barrel. Since finalizing our forecast on Friday, the futures curve for oil prices has already moved higher. 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. As we've said before, we will not let higher oil prices become persistent inflation. The two biggest risks to the projection are still the conflict in the Middle East and our trade relationship with the United States. There are also domestic risks to our inflation outlook. As inflation comes down, there's a risk that it gets stuck above the 2% target. If cost increases and their pass-through are larger than expected, or the economy recovers faster than expected, inflationary pressures will increase. On the other hand, there's a risk that the second quarter pick-up in growth is not sustained. The recovery in exports could stall, which would likely weigh on business investment and hiring. A weaker economy would mean more downward pressure on inflation. Based on the MPR projection published today, Governing Council judges the current policy rate remains appropriate to sustain the economic recovery and bring inflation back to the 2% target. However, uncertainty is still high. Governing Council will continue to assess the strength of the Canadian economy and the outlook for inflation and is prepared to adjust monetary policy as needed. The bank is committed to maintaining Canadians' confidence in price stability through this period of global upheaval. And with that, the Senior Deputy Governor and I will be very pleased to take your questions.

There, since our last report in April, there have been quite a number of economic indicators. And certainly what they're suggesting is the economy is now expanding. And the signs, as that data have come in, have become clearer. For the second quarter, we're estimating growth of about 2 and 1/2%. So, where is that coming from? Well, a few sources. First of all, we've seen continued resilience on behalf of Canadian households, consumers. Consumer spending has remained pretty solid through this. The housing market had been weak. It had actually been contracting. It looks like it's stabilizing, so it's probably not going to add a lot to growth, but it's not going to be subtracting from growth. I think where we're seeing a bit more momentum is in exports. Exports, as you know, have adjusted to US tariffs. And they now look to be growing again. Yes, they're growing along a lower path than what they were on, but they are getting back to growth. I mean, when we talk to businesses, what we're hearing is they're adapting to this uncertainty. The other thing is that the US economy is strong. That is creating strong foreign demand for our exports. US orders are starting to come back. Businesses are, in some cases like aluminum, businesses are finding new markets in Europe, for example. So, we're seeing a certain adaptation. And with more strength in exports, we think there'll be a pick-up in business investment. Certainly we expect to see some boost in the near-term in business investment coming out of the oil and gas sector. Higher oil prices are encouraging more investment in oil and gas. So, you put those things together, the second quarter is looking, we already have a fair amount of data for the second quarter, that's looking pretty solid. I think the thing that we're going to be assessing going forward is how sustainable is that pick-up. We think, when we talk to companies, when we look at the sort of change in momentum, we do think it is sustainable. But yes, there is a risk. Growth, particularly exports, could stall going forward. If exports stall, I think investment will stall, hiring will slow down. So, there are some risks, but increasingly the economy is looking like it is in expansion.

The short answer to that question is yes. But let me emphasize a couple things. If you go back to our April report, we outlined a scenario where oil prices were high and they stayed high. And what we indicated is in that scenario, if that happens, the likelihood that higher oil prices start to pass through to prices of other goods and services, inflation becomes more generalized, and starts to become more persistent, and we indicated in that scenario, yes, we would likely need at least consecutive hikes in interest rates to get inflation back to our target. So, where are we today? Well, today oil prices are lower than their peaks in April. Obviously, in the last week you've seen them back up considerably. They're about halfway back to where they were. And look, let's be frank. The situation in the Middle East remains very volatile. It looks like it's a long way from being resolved. And so, yes, if oil prices go higher and they remain higher, there may well still be a need for consecutive hikes. I do want to stress, though, that's not our base case. It wasn't our base case in April. It's not our base case now. Our base case now is that oil prices will gradually ease. Inflation in Canada will also gradually ease. But it is a risk. And the thing I would just underline is it's not only risk. For example, in my response to the previous question, we are more encouraged that growth is picking up. But there are questions about how sustainable that pickup is. And if exports stall, if investment weakens again, if housing slows, there'll be more excess supply in the economy, more downward pressure on inflation. So, there are risks on both sides. And where we landed today is that at this moment our best judgment is where we are now looks appropriate, but we underlined uncertainty is high and we're prepared to adjust monetary policy as needed.

Well, you described our outlook pretty well. I'm not sure how much more I can add, really. Look, I'm not going to handicap the next decision. We're going to take our decisions one at a time. I think what I would emphasize there is monetary policy has been facing this dilemma, as you suggested. Inflation is high. It's above our target. It's actually a little bit outside the 1 to 3 band. Growth's been weak. The economy hasn't really shrunk over the last year, but it hasn't grown, either. And there's considerable excess supply in the economy, which means there's room for the economy to grow without creating inflationary pressures. The thing is you can't at the same time raise rates to lower inflation and lower rates to raise growth. So there's a dilemma. As what we're seeing relative to where we were is that if this forecast plays out, that dilemma will be resolving itself. As you said, growth will be picking up, inflation will be coming down, and in that sense, yes, it's a fairly positive outlook. There are risks around that outlook which I've already talked about. The reality is that the world's an uncertain place and there's always some uncertainty about just how events will play through, how they will affect the Canadian economy, how quickly it's adapting, how quickly higher costs will get passed through. We'll be watching all those things and as we've indicated, we're prepared to respond as needed.

Well the short answer Paul is it's been a major factor. Canadian dollar has depreciated about a couple of cents since the last decision. We, as you know, we don't target the Canadian dollar. A flexible exchange rate is an essential part of our monetary policy framework. It allows us to set interest rates in Canada for the needs of the Canadian economy. And I think as we mentioned in the report, you've seen some widening in government bond yields between Canada and the United States. I think that's weighed a bit on the Canadian dollar. As we highlighted in the report, a weaker Canadian dollar does make our exports a little more competitive. At the same time, it does increase the costs of imports into Canada. We don't forecast the Canadian dollar. We've assumed a 71 cent dollar going forward in our forecast. So, that effect is about 2 cents, which is a pretty small effect in our forecast. The boost to inflation would be pretty small and the impact on exports would be pretty small. It's not a major consideration in the forecast. But yes, it is embedded in the forecast.

Well, these are major projects that are in the development stage, so they don't show up, it'll take a long time before they show up in the hard economic data. Your question about confidence, it would be hard to discern any one project's effect on confidence measures from the survey data that we track. But I think what you could say is that the move up in optimism that we have in this outlook is affected overall by confidence and I think it would be reasonable to think that one of the things contributing to that is some of these larger project announcements.

Well, you're certainly right that the war continues and is ongoing. I certainly cannot predict when it might get resolved. So, there are certainly some risks there. With respect to what's happened since the war started about 4 and 1/2 months ago, oil prices initially went up very sharply. They peaked in April, little over $120 a barrel. They actually then came down quite a bit to about 70-75 bucks US. Obviously, you've seen in the last week, they've gone back up closer to around $85. So, they've backed up quite a bit, although they're still a lot lower than they were in April. And yes, the longer oil prices stay high, the bigger is the risk that that begins to spill over into the prices of other goods and services and inflation starts to broaden. It becomes more generalized. And that would certainly be a signal, a warning sign to us. The sort of progression is, right now what you see in the data is that inflation is very concentrated in gasoline. The cause of inflation is very concentrated in gasoline prices. Headline CPI inflation, the latest reading is 3.2%. CPI excluding gasoline is only 2.2% and our measures of core, the trim and median, are very close to 2%. So far, it's very concentrated in gasoline prices. We will be assessing very closely the spreading. We expect to see some pass-through of higher oil prices to other prices, and we've built that into our projection. I think in the monetary policy report, we indicate the peak effect is about 0.4 on CPI inflation. In the projection though, that is being somewhat offset by the fact that the economy is in excess supply. That's putting some downward pressure on prices. So, inflation, provided oil prices do come down, eases in Canada. There are risks. Clearly, if oil prices go higher, they stay higher, the likelihood that that gets passed on, it broadens, increases, and there's a progression from broadening to persistence. And yes, if that happens, we may well need to raise interest rates. That's not our base case, but it is a serious risk.