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The uncertainty entering this trade war leaves the Bank of Canada in a bind when it decides on interest rates Wednesday

— Economist Paul Matsiras, Moody’s Analytics

The Bank of Canada is widely expected to raise interest rates this week.

Oh, but maybe it shouldn’t.

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Economists say there’s more than enough justification for governor Stephen Poloz, senior deputy Carolyn Wilkins and their colleagues to raise their benchmark overnight rate by one-quarter of a percentage point to 1.5 per cent Wednesday.

But at the same time, Canada is embroiled in a trade war with the U.S. that threatens to escalate. The latest economic readings seem generally solid but hardly exceptional. The household debt picture is improving but still troubling. We’re still adjusting to earlier rate hikes and new mortgage-qualification rules. And inflation, though above the central bank’s target, isn’t out of hand.

That’s a lot for central bankers to juggle in this new era of uncertainty, as the Trump administration changes the rules of the game with import tariffs that have sparked retaliation by several trading partners, including Canada.

Bank of Canada senior deputy governor Carolyn Wilkins and governor Stephen Poloz

PATRICK DOYLE/The Canadian Press

Key will be whether the Trump administration follows through with its threat to punish auto imports, which would hit Canada, and Ontario in particular, hard, possibly driving the country into a recession. Thus, the Bank of Canada could find itself in the position of having to cut rates down the road.

Mr. Poloz and Ms. Wilkins won’t be held hostage by trade-related headlines and comments, but they’re obviously concerned about how this conflict plays out.

“The uncertainty entering this trade war leaves the Bank of Canada in a bind when it decides on interest rates Wednesday,” said economist Paul Matsiras of Moody’s Analytics, sister company to the credit-rating agency.

“The case for a rate hike is pretty straightforward,” Mr. Matsiras added. “The economy is booming, with unemployment hovering at the lowest rates on record going back to the mid-1970s. Paired with accelerating wage growth that will support consumer spending, this would normally warrant further removal of monetary stimulus measures.”

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The big but: “The length of the trade war is one major concern, while changes to mortgage regulations are another source of volatility. Finally, it is still too early to judge the economy’s sensitivity to higher interest rates given the accumulation of household debt. Until a clearer picture emerges, the bank will remain cautious.”

Mr. Matsiras expects the central bank to hold rates steady this week, but many others believe it will act. The market thinks so, too.

“Leaving aside the trade rhetoric/uncertainty for a moment, the Canadian economic backdrop is fully consistent with higher policy rates,” said Benjamin Reitzes, the Bank of Montreal’s Canadian rates and macro strategist.

“The output gap is closed, inflation is close to target and growth is projected to be at or above potential.”

David Rosenberg, chief economist at Gluskin Sheff + Associates, has some counter-arguments, put forth in a report titled “Some reasons for the BoC not to go!”:

The latest Ivey purchasing managers index (PMI) – a measure of the manufacturing sector – was still in positive territory, but declined markedly in May from April.

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The Bank of Canada’s last business outlook survey, which helps guide its decisions, may have been strong, but the parts of the survey that signal expected sales growth and capital spending both declined.

Not only that, other analysts noted that most of the survey was done before the United States hit Canada with tariffs on steel and aluminum.

The central bank will also release its monetary policy report this week, which could include tweaks to its economic forecast.

“We could see another trade uncertainty-driven downgrade in this [monetary policy report],” BMO’s Mr. Reitzes said, but added the change would be marginal.

“Inflation could see a small downgrade after the soft May print, but nothing that would impact policy.”

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Aside from the Bank of Canada, it’s something of a lazier summer week to start with, but will pick up steam as the major U.S. banks start reporting results. The rest of the calendar:

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MONDAY: TAKING STOCK

We’ll see how markets open after last week’s gains despite global trade fears.

The S&P 500 gained 1.5 per cent last week, pushed higher by stocks in the health care, utilities and tech sectors, BMO senior economist Robert Kavcic noted.

“The index is now up 3.2 per cent on the year, with small-caps outperforming the big guys by an 11-per-cent to 3-per-cent margin,” Mr. Kavcic said.

“Meantime, the TSX added 0.6 per cent, with strength confined to relatively lightweight sectors – banks and energy were modestly higher on the week,” he added.

“Global markets were mixed, with Europe notching solid 1-per-cent or better gains, while China fell 4.2 per cent as the selloff continues – now more than 12 per cent in the past month.”

In the corporate sphere, Alimentation Couche-Tard Inc. reports quarterly results.

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TUESDAY: ON THE HOME FRONT

Economists expect Canada Mortgage and Housing Corp. to report residential construction starts rose more than 7 per cent in June to an annual rate of 210,000 or better, and for Statistics Canada to report a 4-per-cent rise in building permits.

Royal Bank of Canada economists forecast that housing starts could show a rise of almost 10 per cent to 215,000, following a plunge in May.

“With the most recent permits data through April remaining strong at 227,000, on a three-month moving average basis, our expectation is that the May weakness will not persist with new construction bouncing back in June,” RBC said.

PepsiCo Inc. also reports results.

WEDNESDAY: CARNEY IN SPOTLIGHT

Besides the Bank of Canada, its former chief Mark Carney, now Governor of the Bank of England, speaks at a Boston conference.

There are several quarterly earnings reports, too, including those from Aphria Inc.

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THURSDAY: INFLATION RISE

There are some things worth watching, such as industrial production numbers from Europe and a meeting of euro zone finance ministers, but the biggie is the U.S. inflation report.

Economists generally expect to see a rise in June to an annual rate of 2.9 or 3 per cent.

“U.S. inflation has been heating up this year, owing partly to a run-up in energy prices recently,” CIBC World Markets’ Katherine Judge said.

“But, despite our expectation for a trend-like 0.2-per-cent monthly gain in headline prices in June, that should still be enough to nudge headline inflation up to 3 per cent. That will be the strongest rate of gains seen since 2011.”

Key for markets will be what the report suggests about the U.S. Federal Reserve’s rate-hiking cycle.

“Despite headline inflation picking up, the Fed has little reason to further accelerate the pace of rate hikes at this point,” Ms. Judge said. “The effects of tariffs up to this point on consumer prices should be lagged and only modest.”

FRIDAY: BANK EARNINGS

The Fed gives its monetary policy report to Congress, while U.S. bank earnings kick off with JPMorgan Chase & Co., PNC Financial Services Group Inc. and Wells Fargo & Co.

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