Bank of Canada holds key rate steady at 2.25%, predicts economic rebound

The Bank of Canada is holding its policy rate at 2.25 per cent and says that it expects the Canadian economy to improve, despite flatlined growth over the past 18 months.

But there are big caveats. Although the economy is showing signs of improvement and inflation is easing, the BOC’s new monetary policy report released today warns that uncertainty driven by U.S. tariffs and the war in the Middle East could knock potential growth off course.

The BOC report indicates that the level of gross domestic product was “roughly unchanged from the first quarter of 2025 to the first quarter of 2026.”

GDP growth was close to zero, weaker than the 1.5 per cent growth the central bank projected in April.

Growth was dragged down last quarter by several temporary factors.

According to the report, this included an unexpected decline in government spending, a fall in motor vehicle production and a sudden drop in oil and gas investment.

Housing activity also dropped in the first quarter “hampered by affordability challenges, slow population growth and elevated economic uncertainty.”

However, consumer spending “remained resilient” last quarter despite elevated uncertainty and higher gas prices.

The BOC says that there was a “rebound” in the second quarter between April and June, which saw a pickup in exports and residential investment. As a result, the central bank estimates the economy will grow just above one per cent in first half of 2026.

Inflation risks

The outcome of Canada’s trade relationship with the United States and the war in the Middle East remain the two biggest risks which could drive up the cost of living.

Headline inflation has risen above three per cent but could come down if oil prices and gasoline refinery margins decline. Inflation excluding gasoline remains near two per cent.

The report’s projection doesn’t take into account that a ceasefire between the U.S. and Iran has broken down in recent days and that commercial ship traffic in the Strait of Hormuz has once again slowed to a trickle.

Inflation, excluding gasoline, remains near two per cent.

The bank says that the Canadian economy has been adjusting to U.S. tariffs and the continued uncertainty surrounding the review of the Canada‑United States‑Mexico Agreement, but that business investment has remained roughly flat.

The unemployment rate has generally fluctuated between 6.5 per cent and seven per cent, which the BOC says point to excess supply in the economy.