Bank of Canada set to hold rates as strong growth collides with trade risks

OTTAWA, Sept 2 - The Bank of Canada appears to be on track to maintain its key policy rate at 2.25% for the time being, despite the recent robust economic growth. Canada's economy expanded at an annualized rate of 3.3% in the second quarter, surpassing the central bank's forecast of 2.5%. This surge was fueled by a surge in exports and domestic demand, as well as a rise in business investment and household spending.

However, the improvement is marred by the new trade dispute with the United States, which recently introduced steep tariffs on approximately $20 billion worth of Canadian goods. Canada has retaliated by imposing similar duties on US imports, set to take effect next week. The conflicting factors have left the central bank with little impetus to adjust borrowing costs, either up or down, until a clearer picture emerges of how the trade dispute impacts growth and prices.

Randall Bartlett, the deputy chief economist at Desjardins Group, noted that the risks are evolving and broadening, but they still remain fairly balanced around inflation. The central bank would consider moving rates only after understanding the long-term impact of the tariff changes. Currently, inflation is showing little sign of justification for a rate move, with headline inflation increasing to 3% in July, near the upper limit of the BoC's 1%-3% target range.

This surge was primarily driven by higher gasoline prices. Meanwhile, core inflation, which the bank prefers, remains close to its 2% target.

Economists polled by Reuters expect the Bank of Canada to hold rates steady at Wednesday's meeting, with a near 94% probability of no change. The labor market has also shown signs of improvement, with the unemployment rate dropping to a two-year low of 6.4% in July following strong job gains. However, the rate remains elevated compared to historical norms.

Economists have warned against attributing excessive significance to the second-quarter economic rebound, as it was partly fueled by the restart of car manufacturing plants, higher oil prices, government support, and the joint hosting of the soccer World Cup by Canada.