The Bank of Canada cut its key interest rate in a widely expected move on Wednesday as economists warn U.S. President Donald Trump’s trade war threatens to plunge Canada into a recession.
The bank reduced the policy rate by 25 basis points, bringing it to 2.75 per cent from three per cent.
While central bankers refrained from using the R-word during a news conference following the announcement, they did say that U.S. tariff threats have hurt business and consumer confidence, which supported their decision to provide relief to the economy.
Still, Bank of Canada governor Tiff Macklem emphasized that the bank will remain cautious about future rate cuts, as it cannot offset the destructive impacts of a trade war.
“What it can and must do is ensure that higher prices do not lead to ongoing inflation,” Macklem said. In a trade conflict, while the economy shrinks due to declining demand, retaliatory tariffs and a weaker Canadian dollar put pressure on consumer prices.
Macklem also said that making a larger move in March wasn’t really on the table. “We did not seriously consider a cut of 50 basis points.”
“You can’t see much damage from the trade war in the hard data yet. But when you look at the survey data, it’s pretty clear that consumer confidence, business confidence, have been sharply affected,” Macklem said.
The central bank’s surveys showed that trade tensions are making Canadians worry about job security and financial health, especially those working in sectors like manufacturing, mining, and oil and gas, which are highly dependent on trade with the U.S. Meanwhile, 40 per cent of businesses said they plan to reduce hiring and investment.
“Canadians are preparing themselves,” senior deputy governor Carolyn Rogers said. “We’re seeing saving rates go up, discretionary spending go down.”
“I think Canadians are responsible. They’re reading the news, they’re watching this with the same level of concern we have and they’re preparing in the best way they can.”
Most economists had believed the bank would pause cuts in March due to signs of rising inflation, but many changed their forecasts since the U.S. launched the trade war last week.
“Indeed, absent trade risks, the Bank of Canada likely would have held rates,” RBC economist Claire Fan wrote in a note to clients. “As much as developments with the U.S. administration can change on an hourly basis, we know broader trade tensions aren’t going away.” RBC expects the central bank’s key rate to reach 2.25 per cent around mid-year, Fan said.
Effective Wednesday, Trump slapped a 25 per cent tariff on Canadian steel and aluminum after backing off his 50 per cent tariff threat. As of Wednesday afternoon, Canada’s counter-tariffs were poised to take effect on Thursday.
Despite adding to prices, Rogers seemed supportive of the federal government’s decision to retaliate. “Governments need all the tools they can get in a trade war,” she said. “Retaliatory tariffs are really designed to try and get us back to a mutually beneficial trading relationship. That’s a goal we all want.”
Bank officials are still evaluating just how quickly tariffs will pass through to consumer prices. “We don’t expect that the supply constraints from the tariffs and the trade war will run into the same surge in demand we saw (post-pandemic),” said Rogers. That means that we might not see the same speed or magnitude of pass-through prices, she added.
But around half of businesses surveyed by the bank said they plan to increase their prices if tariffs are imposed on their products. Of those, 75 per cent expect to pass on more than half of the tariff-related cost increases to customers.
Macklem said that the bank is tracking the impact of tariffs on inflation by different good categories. “If you’re buying fruit and vegetables from the United States, you’ll probably see pretty rapid pass-through on something like that — these are perishable goods. On more differentiated, more durable goods, you might expect to see slower pass-through.”
January inflation rose to 1.9 per cent, according to Statistics Canada. While that’s below the central bank’s two per cent target, a StatCan economist noted that inflation would have been 2.7 per cent if not for Ottawa’s tax holiday.
The February inflation data release is scheduled for March 18.
