Bank of Canada watchers expected a firmer stand on inflation from the central bank after oil prices surged to US$100 in the Iran war, but even they were surprised at last week’s hawkish tone.

Not only did governor Tiff Macklem warn that interest rates could be adjusted “even if the economy evolves broadly in line” with the bank’s projections, he also said “consecutive increases” may be needed if energy prices rise further and remain high.

“At face value, this suggests our view that the bank will wait until 2027 to begin hiking rates is dead in the water,” said Bradley Saunders, North America economist for Capital Economics.

That’s the view markets are taking. After the bank’s decision to hold rates last week, market bets on rate hikes increased and are now pricing in almost two 25-basis-point increases by October.

Many economists are sticking with their forecasts that the bank will stand pat this year, but they admit that the odds are rising that hikes could come sooner than expected.

Capital thinks the Bank of Canada will keep its powder dry this year because a weaker economy will outweigh the threat of inflation.

Canada’s gross domestic product returned to growth in February, but the early estimate for March is flat, suggesting that a jump in oil and gas extraction that supported growth at the start of the year has since become a drag, said Saunders.

Moreover, a third of consumers in the bank’s own survey said they were cutting or postponing major spending because of the impact of the Iran war.

“Accordingly, we think the bank’s forecast for GDP to rise by 1.5 per cent annualized in both the first and second quarter looks a little punchy,” he said.

The Bank of Canada may also be putting too much faith in promises of federal stimulus, said Capital. The latest monetary policy report cites government spending as a key reason to expect higher growth this year, but Ottawa’s fiscal update last week showed little near-term stimulus beyond previously announced measures. New spending promised in November’s budget focused on long-term investment.

The economists also worry that the upcoming review of the Canada-United-States-Agreement could leave Canada worse off than it is now. The central bank’s forecast depends on tariffs staying at current levels, but trade tensions between the two countries have been escalating.

All of this leads Capital to believe that growth this year will amount to just 0.9 per cent, a ways below the central bank’s forecast of 1.2 per cent.

But then there’s those skyrocketing oil prices — and the Bank of Canada faces a tricky navigation between the risks of a weak economy and runaway inflation.

“$100 per barrel WTI is not to be sniffed at — especially with food prices awkwardly high,” said Saunders.

The European Central Bank official said today a rate hike in June was “all but inevitable,” if energy prices remain high, but Capital thinks the Bank of Canada will wait until at least July before committing.

By then US$100 oil could be a thing of past. Mind you, that’s a big if — and not all economists expect the bank to hold fire.

Scotiabank Economics is calling for three hikes this year which would bring the interest rate to 3 per cent.

“Six more weeks of this and it will be harder for Macklem & Co to sit tight,” said Derek Holt, head of the Scotiabank’s capital markets economics.

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The Iran war is disrupting shipping and air-flight corridors that are critical for global energy and goods, and according to the International Monetary Fund there is “no neat and clean return to the way things were.”

These IMF charts show why. In 2023, Houthi forces in Yemen attacked commercial ships passing through Bab el-Mandeb Strait forcing ships to reroute around the Cape of Good Hope in Africa. More than two years later traffic still remains at about half what it was before the conflict.

Transport through the Strait of Hormuz and Middle East air flights have plummeted since the Iran war started in February, and if their recovery is as slow as the Bab el-Mandeb “the drag on growth will persist long after the fighting stops,” said the IMF.

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Sell in May, and go away; markets climbing the wall of worry — investing is full of rules of thumb like these, little snippets of advice designed to help you remember some rules and become a better investor. Investing columnist Peter Hodson takes a gut-check on five investing axioms to test how they stand up in the current market environment. Read more

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Today’s Posthaste was written by Pamela Heaven with additional reporting from Financial Post staff, The Canadian Press and Bloomberg.

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