Investment bank UBS is forecasting that the Bank of Canada will keep its key interest rate unchanged for the remainder of this year and will not raise it again until the second half of 2027. The prediction comes even after the central bank's latest policy statement struck a slightly more optimistic tone about the economy.
In a research note released Thursday, UBS Global Research said the Bank of Canada's recent statement acknowledged some improvement in economic data and the possibility that inflation could cool further. However, UBS argues that the underlying conditions have not shifted enough to warrant a change in the central bank's cautious stance.
What's Driving the Hold?
The core of UBS's argument rests on what it calls 'considerable excess supply' in the Canadian economy. This is a term economists use to describe a situation where the economy is operating below its full capacity. In plain terms, it means there is more productive capacity—factories, workers, and resources—than there is demand for goods and services. When there is excess supply, businesses find it harder to raise prices, which naturally keeps inflation in check.
UBS believes this slack will persist, meaning the Bank of Canada does not need to raise rates to cool demand. Instead, the central bank can afford to wait. The bank also points to uncertainty surrounding the USMCA trade agreement as a key factor. The USMCA, which governs trade between the United States, Mexico, and Canada, is up for review, and any changes could have significant implications for Canadian exports and business investment. This uncertainty makes the Bank of Canada more cautious about tightening policy.
The Bank of Canada has already held its rate steady in recent meetings, as reported in our coverage of the BoC's latest decision. The central bank has been balancing the need to control inflation against the risk of slowing the economy too much.
What It Means for Investors
For everyday investors, a prolonged period of steady interest rates has several implications. First, it suggests that borrowing costs for mortgages and business loans will remain at their current level for the foreseeable future. This can be a positive for real estate and consumer spending, as we've seen with the recent rally in financial and real estate stocks following the Bank of Canada's hold at 2.25%.
Second, it means that the Canadian dollar, or loonie, may not see a sharp appreciation from higher interest rates. A weaker loonie can benefit exporters but also makes imported goods more expensive. The loonie's recent rally faded after the Bank of Canada held rates and dropped its hike warning, as we noted in our analysis of the loonie's performance.
Third, investors in bonds and fixed-income products should expect yields to remain relatively stable. If the Bank of Canada is not raising rates, long-term bond yields are less likely to spike, which supports the value of existing bond holdings.
However, UBS's forecast is not without risks. If inflation proves stickier than expected—especially if oil prices remain elevated—the Bank of Canada may be forced to act sooner. The central bank has already noted that sticky oil inflation has delayed the return to its 2% target, as highlighted in our report on the impact of oil prices on rates.
Broader Economic Context
The Canadian economy is navigating a complex environment. While consumer spending has remained steady, as noted by big banks, wholesale sales have been flat, and inventories are dipping. This suggests that businesses are cautious about building up stockpiles, which aligns with the idea of excess supply.
UBS's view contrasts with some other forecasters who expect the Bank of Canada to begin cutting rates later this year or in early 2026. The divergence highlights the uncertainty in the outlook. For now, UBS is betting that the central bank will prioritize patience over action, waiting until 2027 before it feels confident enough to raise rates again.
Investors should watch for upcoming economic data, particularly inflation reports and GDP figures, as well as any developments on the USMCA front. These will be the key drivers of the Bank of Canada's decisions in the months ahead.
