At a policy panel at the European Central Bank’s (ECB) Forum on Central Banking on Wednesday, Bank of Canada (BoC) Governor Tiff Macklem said Canada’s economy remains soft while inflation is still running clearly above target. He added that the policy rate is at the bottom end of the neutral range and described it as about the right level to keep inflation contained.
Macklem said the outlook is subject to uncertainty and that the BoC is prepared to take action if conditions change. He also pointed to US investment in artificial intelligence as a source of headwinds and competitive pressure, and said it remains an open question when any AI-driven disinflation will kick in. In the near term, he said computer prices have risen.
Soft Economy And Stubborn Inflation Complicate Policy
We see the Canadian economy is soft, with the latest GDP report for the first quarter showing a slight contraction and June’s job growth missing expectations. Yet, inflation remains a problem, as the last CPI print came in at a stubborn 3.2%, well above the 2% target. This puts the central bank in a very difficult position.
The signal is that interest rates are likely at the right level to contain inflation, suggesting a pause for now. This makes the upcoming rate decision on July 15th a major event, with overnight index swaps currently pricing in only a small chance of a rate cut this summer. We believe traders should watch for any surprise in the next jobs report to cause significant repricing in CORRA futures.
Market Volatility And AI-Driven Uncertainty
This uncertainty creates headwinds for the Canadian dollar, especially as investment flows towards US AI initiatives. We expect implied volatility on USD/CAD options to remain elevated, reflecting the market’s indecision. A strategy that benefits from a large price move, regardless of direction, could be positioned well for the coming weeks.
The long-term disinflationary impact from AI is still an open question for us. In the short term, we have actually seen price increases in related technology components, which complicates the inflation outlook. For now, this factor adds to market confusion rather than providing a clear trading signal.
We must be humble amid this uncertainty, as the situation can change rapidly. We remember how markets were caught off guard by the Bank’s sudden pivot in late 2025 when the economy weakened more than expected. We are therefore prepared to act quickly if new data forces the Bank’s hand in either direction.
