There is little in the data to justify a more hawkish shift from the Bank of Canada at its Wednesday policy meeting, said ING.
April inflation undershot expectations with the headline consumer price index rising more modestly than feared to 2.8% year over year from 2.4% -- the market consensus had been 3.1% -- while core inflation surprisingly slowed.
Meanwhile, the labor market has been mixed, noted the bank. After losing 112,300 jobs in the first four months of the year, employment rebounded by 87,800 in May, but the unemployment rate remains elevated at 6.6%.
The biggest headlines were generated by the fact that Canada is now in a technical recession after the economy contracted 0.1% annualized in Q1 after a 1% drop in Q4 2025. In fact, Canada has recorded three quarters of negative growth out of the past four, meaning that the BoC's previous 1.2% full year gross domestic product forecast looks set to be missed.
The early estimate for the monthly April GDP print is better at 0.4% month over month, but while higher energy prices are a boon for Canada's economy, given it is a major net producer of oil and natural gas, the ongoing uncertainty about trade policy continues to hold back sentiment, stated ING.
The coming evaluations of the United States-Mexico-Canada trade deal and the potential for the U.S. to put more of a squeeze on trade partners prompted BoC Governor Tiff Macklem to warn that a further rate cut cannot be ruled out if rule changes significantly harm Canada.
Financial markets continue to price a 25bps rate hike before year-end, pointed out the bank. Given the weak activity backdrop, soft jobs market and the lack of corporate pricing power in the economy, ING expects interest rates to remain unchanged at 2.25% through until early 2027.
That said, Canada's monetary policy stance remains accommodative and once the economy stabilizes and investors have clarity on the U.S.-Canada trade relationship, the bank estimates interest rate hikes from Q2 2027 onwards.
Short-term rate differentials are adding upward pressure to USD/CAD, largely due to the hawkish repricing in Federal Reserve rate expectations, added ING. While the Canadian dollar (CAD or loonie) is an oil-sensitive currency, any further rally in crude is unlikely to benefit the currency.
This is primarily because the hit to global risk sentiment would benefit the safe-haven US dollar (USD). The lack of progress toward a reopening of the Strait of Hormuz means 1.40 could be tested in the very short term.
In a benign scenario where oil flows resume, ING thinks CAD would still lag most G10 currencies. European currencies would get a lift from the improved terms of trade thanks to the drop in energy prices, and markets would likely reward currencies that offer a strong domestic story.
Canada lacks such a story, in the bank's view, given a relatively dovish central bank and ongoing domestic headwinds linked to USMCA uncertainty and labor market volatility.