U.S. President Donald Trump’s 25-per-cent tariffs are still nothing more than a threat, but they’re already forcing policymakers to prepare for the worst-case scenario.
The Bank of Canada delivered a quarter-percentage-point cut to its key interest rate on Wednesday, emphasizing Trump’s tariff threat in the first rate announcement of the year.
“There’s no doubt that weighed on our decision,” Bank of Canada governor Tiff Macklem said in a press conference.
The bank lowered its policy rate to three per cent from 3.25 per cent in line with experts’ expectations, according to a Bloomberg survey of 22 economists.
If the U.S. broadly imposes tariffs on Canadian goods — which might come as soon as Saturday — the Canadian economy could be pushed into a recession due to lower demand for exports, economists say. This would prompt the central bank to boost economic stimulus by cutting rates further.
At the same time, if Canada decides to retaliate, it would increase prices for Canadian consumers, possibly leading the bank to consider rate pauses or even hikes going forward.
Macklem said the bank is evaluating possible responses to different scenarios, but ultimately, there is not much central bankers can do to offset the harsh economic consequences of a trade war.
“This is a complex shock for monetary policy because growth goes down and inflation goes up, and we can’t lean against lower growth and higher inflation at the same time,” Macklem said. “So we’re going to have to weigh which one is bigger.”
“The reality is, the economy is going to work less efficiently. Canada is going to produce less, it’s going to earn less. Monetary policy can’t change that,” he said. “What it can do is, it can help the economy adjust to that and to try to be a source of stability.”
Desjardins economist Royce Mendes said he believes the cut is “justified.”
“There are enough reasons to cut interest rates even without the threat of tariffs,” he told the Star, citing a softer labour market and slowing population growth among the signs currently pointing to a weaker economic outlook.
“I think that there is reason to believe that Donald Trump is going to make good on the threat of tariffs to Canada,” said Mendes, “and getting a little bit ahead of the game by lowering interest rates (by) a quarter point is helpful because you’re starting from a position that is less restrictive on the economy.”
BMO economist Douglas Porter, on the other hand, suggested that the concern over imminent tariffs played a larger role in the decision, as the bank highlighted that consumer spending and housing market activity have picked up since more aggressive past cuts.
“If not for the tariff threat, we would be talking about the bank moving to the sidelines today,” he wrote in a note to clients.
Macklem said the bank will be stepping up its community outreach, which includes business and consumer surveys, to get a better understanding of how trade uncertainty is impacting Canadians.
Along with the interest rate decision, the bank released its quarterly monetary policy report with updated forecasts for inflation and growth in the Canadian economy.
The outlook, however, does not incorporate any U.S. tariffs while recognizing that rising trade tensions are already affecting financial markets and businesses.
Without tariffs, central bankers expect inflation to remain close to the two per cent target and economic growth to pick up.
The report also includes a “severe” hypothetical scenario. It models a world where the U.S. imposes permanent tariffs of 25 per cent on all imported goods, including from Canada, followed by an equal retaliation from trading partners.
In this world, real Canadian gross domestic product would take a 2.5 per cent hit in the first year, while inflation would generally rise, reflecting a weakened Canadian dollar.
“Next steps clearly are dependent on what unfolds on the trade front,” said Porter. “We suspect while the bank may initially respond cautiously to a trade war, eventually it would be compelled to cut much more than the market currently expects.”
