By Michael O’Neill
The Canadian economy is flying into a stiff and shifting headwind, and the loonie can’t even find a thermal. Bank of Canada officials are fully aware of this, but they are treating these issues as problems for another day.
Today’s Bank of Canada policy decision delivered exactly what markets expected. The overnight rate was left unchanged at 2.25%, growth is projected to limp along just above 1%, and while oil is adding noise to inflation, underlying price pressures remain contained. In short, the Bank is comfortable staying on hold and letting incoming data dictate the next move.
The latest Monetary Policy Report (MPR) reinforces that stance. The domestic economy is not strong, but it is not breaking either. Real GDP is tracking near 1.2% this year with only a gradual pickup into 2027. The labour market has softened but remains intact, and core inflation metrics such as CPI-trim and CPI-median are hovering close to target. Longer-term inflation expectations are still anchored, giving policymakers little urgency to act.
Put that together and you get a central bank that is not in a hurry to move.
Trade Animosity
The Bank of Canada’s base case assumes the 2026 CUSMA review preserves the existing trade framework. That is a significant assumption, and recent rhetoric from Washington suggests the risk of a poor outcome is more elevated than markets are pricing.
Policymakers acknowledge that an escalation in tariffs or a deterioration in market access would weigh heavily on exports, business investment, and confidence, forcing a policy response. But the MPR treats trade as a downside scenario, not a central risk. The BOC acknowledged that the CUSMA negotiations are the single biggest risk to the outlook but preferred to take a more optimistic approach. That tactic could backfire.
US Commerce Secretary Howard Lutnick and Trade Representative Jamieson Greer are using inflammatory rhetoric while signalling an increasingly aggressive posture heading into the review. Lutnick opined about what he thought was a delaying tactic by Canadian negotiators, saying “That is like the worst strategy I’ve ever heard. They suck.” Greer said about Canada, “They’re doubling down on globalization when we’re trying to correct for the problems of globalization.”
The comments are more schoolyard taunts and hardly the serious discourse expected from diplomats, but nevertheless, they may put Canada’s reputation for politeness to the test.
Oil Cards Are Wild
The problem is not the domestic economy. The problem is oil.
Disruptions through the Strait of Hormuz are a major threat to global supply. The waterway normally carries about 20 million barrels per day of crude and petroleum products, roughly one-fifth of global consumption and about one-quarter of seaborne oil trade. Prices have risen, but not in a way that cleanly benefits Canada. Higher oil has historically supported the Canadian dollar. This time, that link is weaker.
The Spring Fiscal Update makes it clear that stronger crude boosts government revenues through higher corporate profits, rising incomes, and an uplift in nominal GDP. In simple terms, when oil rises, the tax base expands.
Trump has turned a free-flowing oil-tanker expressway into a one-lane waterway laced with mines, which put maritime traffic to a near standstill. If it remains closed into Q4, some analysts expect Brent (European benchmark) to spike over US$150/b. A move of that magnitude sparked a global recession in 1974, so a spike is not out of the question.
If that were the full story, the Canadian dollar would be higher. It isn’t.
Oil/Loonie Disconnect
The loonie has failed to respond to higher oil prices in the way it historically has.
The reasons are straightforward. Markets doubt the durability of the oil shock. A large share of Canada’s oil sands production, which makes up the bulk of total output, is foreign owned, with U.S. firms holding a dominant stake. That means a meaningful portion of the revenue windfall flows out of the country through dividends and repatriated earnings, offsetting the usual currency support from higher oil prices. It is not a perfect relationship, but it helps explain why the Canadian dollar has remained rangebound even as oil prices have climbed during the latest bout of Iran-related risk aversion.
The Bank can wait on the data, but oil won’t wait on the Bank. That’s how you end up between a barrel and a hard place.
