OTTAWA – The Bank of Canada faces several challenges ahead of its interest rate decision on Wednesday, including a last-minute inflation report, a change in Ottawa's tariff approaches, and ongoing uncertainty regarding government spending plans.

Financial markets largely anticipate that the central bank will break its recent trend of holding rates steady and will cut its policy rate by a quarter point to 2.5 percent, according to LSEG Data & Analytics. Prior to the Bank of Canada’s announcement, the governing council will review August inflation data from Statistics Canada on Tuesday.

Economists project that the consumer price index for Canada will show an increase in the annual inflation rate to two percent in August, up from 1.7 percent the previous month. Tony Stillo, the director of Canada economics at Oxford Economics, corresponds this prediction with his own forecasts, attributing the inflation rise to accelerating prices in the energy and food sectors.

Stillo pointed out that Canada’s counter-tariffs on grocery items, such as Florida orange juice, have likely contributed to persistent food inflation. However, the inflation figures for August will not account for Canada’s recent decision to waive most of these retaliatory tariffs starting in September. He expressed optimism that this move, coupled with Canada’s economic contraction in the second quarter, will help ease inflationary pressures.

Stillo suggested that Canada is “teetering on a recession.” He noted that regardless of whether GDP decreases again in the third quarter, the economy is likely to face challenges in achieving growth during the latter half of the year due to unpredictability surrounding the trade conflict. Despite previously assuming the Bank of Canada’s rate-cutting cycle was over, Stillo has adjusted this forecast in light of the recent tariff adjustments. He anticipates a quarter-point cut in September followed by another in October, bringing the policy rate down to 2.25 percent, which is viewed as the bottom of the bank's neutral range.

A report from TD Economics on September 12 also indicated that the central bank might consider lowering rates due to ongoing trade uncertainties and a weakening labor market that is applying pressure on residual inflation. However, they noted that any unexpected increase in inflation readings might lead the Bank of Canada to remain cautious. The report suggested that recent data trends align with the bank's inflation scenario, which indicates a growing necessity for a policy rate reduction.

In its summary from the July 30 interest rate decision, some Bank of Canada governing council members acknowledged that further cuts could be warranted, particularly should the labor market continue to weaken. Since then, Statistics Canada has reported a collective loss of more than 100,000 jobs over July and August, raising the unemployment rate by two ticks to 7.1 percent. Thomas Ryan, an economist with Capital Economics, noted that labor market weakness now extends beyond sectors directly affected by trade, which he believes will sway other governing council members toward supporting rate cuts.

Given these circumstances, Capital Economics expects the Bank of Canada to implement a rate cut this week, followed by another reduction before the year ends. Throughout the ongoing tariff conflict, the Bank of Canada has generally refrained from adopting an overly aggressive forward-looking approach due to the uncertainties surrounding U.S. trade policy and its effects on the Canadian economy and inflation.

Stillo predicts a shift in the bank’s stance and anticipates a cautious yet pragmatic approach to future rate reductions. He highlighted a critical consideration regarding the upcoming federal budget, which Prime Minister Mark Carney has indicated will involve both austerity measures and significant investments in defense and infrastructure. Stillo noted that the Bank of Canada will closely monitor these spending plans, as they are likely to stimulate the economy and alleviate some pressure on monetary policy.

With trade and fiscal policy still shrouded in uncertainty, Stillo emphasized that the central bank will remain cautiously progressive in its easing measures, wary of implementing substantial interest rate cuts only to reverse them if economic conditions change abruptly. He remarked, “The last thing a central banker wants to do is have to reverse course.”