By Paul Vieira
OTTAWA--The Bank of Canada on Wednesday left its policy rate unchanged at 2.25%, and warned of painful economic repercussions from a prolonged and wider war in the Middle East.
In its latest policy decision, Bank of Canada Gov. Tiff Macklem said it was too early to determine the economic impact from the war in Iran, which is now in its third week. Macklem said officials believe the risk of higher energy costs spreading and lifting prices for other goods and services looks contained at present, citing excess spare capacity floating around in the economy.
Macklem said the central bank is going to look past the war's immediate impact on prices, which he said would push the consumer-price index higher starting in March. "But if energy prices stay high, we will not let their effects broaden and become persistent inflation," he said. "The longer this conflict lasts and the wider it gets, the bigger the risks."
The decision to leave the target for the overnight rate unchanged was widely expected, based on a survey last week of a dozen economists by The Wall Street Journal. Macklem faces a proverbial tug of war in navigating policy, between the risk of a run-up in inflation fueled by supply shocks, as witnessed during the Covid-19 pandemic; and helping a struggling economy under strain from President Trump's protectionist trade policy.
"The Bank of Canada's willingness to tolerate above-target inflation will be tested," said Tony Stillo, the director of Canada research at Oxford Economics. The Bank of Canada sets interest rates to achieve and maintain 2% inflation.
Recent data -- accounting for the period prior to the start of the military conflict in Iran -- indicated inflation in Canada was tepid. Headline inflation in February dropped below the 2% target, and the central bank said that core prices, which strip out the cost of volatile food and energy, and inflation excluding tax changes had both eased toward 2%.
Macklem said economic indicators pointed to slower-than-anticipated growth. Job gains late last year have been reversed after a rocky start in 2026. He added exports are volatile but look soft, and the housing market - once a longtime driver of growth - is weakening. The central bank now expects growth in the first quarter to be below its forecast for a 1.8% annualized increase.
"Risks to economic growth are tilted to the downside," he said, adding the outcome of a U.S.-led review of the existing North American trade treaty remained a "big unknown." About 20% of Canada's gross domestic product is tied to trade with the U.S., and that treaty has allowed most of the country's U.S.-bound exports to avoid Trump administration tariffs.
"Canada's economy is dealing with a lot, and now we face more volatility," Macklem said. "Uncertainty is acute. Trade and geopolitical uncertainties remain, and the conflict in the Middle East has broadened the range of possible outcomes."
Bradley Saunders of Capital Economics said Macklem's remarks had a "dovish" tilt, as he emphasized the deterioration in the growth outlook and played down the immediate risks from higher energy prices. "This will be much to the disappointment of investors, who have moved over the past three weeks to fully price in a rate hike this year," he said.
Higher energy prices would boost national income, as Canada is a net crude-oil exporter. At the same time, Macklem said higher prices for gasoline would squeeze households already struggling with elevated food costs, and leave them with less income to spend on other items. The governor added that financial conditions have already tightened since the start of the Middle East conflict, pointing to higher bond yields, from which lenders price their consumer and business loans; declines in equity markets, which represent a hit to net worth; and wider credit spreads, reflecting increased worry among traders about purchasing riskier assets.
Write to Paul Vieira at paul.vieira@wsj.com
(END) Dow Jones Newswires
03-18-26 1238ET
