Trade war uncertainty is hanging over Canada's economy, Bank of Canada deputy governor says

The Canadian economy has shaken off the weakness seen at the start of the year, however escalating trade conflicts and the related uncertainty are taking a toll, a senior Bank of Canada official said Thursday.

In a speech in Halifax, deputy governor Lawrence Schembri said the Canadian economy has rebounded from its earlier soft patch, but the economic data shows some areas of concern.

Schembri said the Canadian economy is operating close to full potential with low unemployment and inflation right on the central bank's target.

"This solid starting point means the economy has a welcome degree of resilience to possible negative economic developments," he told the Halifax Regional Chamber of Commerce according to prepared remarks released in Ottawa.

"That said, we agree that the data show some areas of concern. Among these is the weakness in consumption ... and, of course, we are concerned about the drop in business investment, which is likely linked to ongoing trade war and related uncertainty."

Rate cut possible?

The Bank of Canada kept its key interest rate target on hold on Wednesday, but said it is keeping a watchful eye on the global economy. The central bank adjusts the rate in order to manage inflation. Many economists have predicted the bank will cut rates later this year.

The central bank's wait-and-see approach this week came as other central banks around the world have been signalling or taking actual action including interest rate cuts to respond to the trade risks and the deteriorating global economy.

"In this uncertain environment, central banks have been conducting monetary policy appropriate to their own circumstances and outlooks. This has contributed to lower bond market yields and reduced borrowing costs in Canada," Schembri said.

"We will continue to ground our decisions in our policy framework, setting interest rates to achieve our inflation target, mindful of the implications for financial vulnerabilities."

The Canadian economy grew at an annual pace of 3.7 per cent in the second quarter, faster than the Bank of Canada expected. The growth was fuelled by rebounds in energy production and exports as well as strength in housing.

Slowdown expected

However, the bank has cautioned that some of the unexpected strength in the second quarter will likely prove to be temporary and predicted growth will slow in the second half of the year.

Schembri said that given Canada's reliance on international trade, a trade war remains the central bank's primary concern and the biggest risk in its forecast.

"Trade policy uncertainty has been weighing on business investment and exports for a couple of years now. And things could certainly get worse internationally, which would deliver a complex shock to our economy affecting both supply and demand," he said.

The Bank of Canada's next interest rate announcement is set for Oct. 30 when it will also update its economic forecast in its monetary policy report.