The Bank of Canada says the Canadian economy would have been in a solid spot right now if it wasn’t for U.S. President Donald Trump’s trade war, and it is worried that high uncertainty could create financial market “dysfunction.”
The bank’s 2025 Financial Stability Report, released Thursday, said Canadians with a mortgage have managed their debt better than expected throughout 2024 while interest rates significantly dropped since June.
Meanwhile, insolvency filings by businesses have also fallen substantially, according to the report.
Those without a mortgage, however, are showing bigger signs of financial stress — though rates of arrears on consumer credit products remain below historical averages, the report stated.
The bank said that, overall, Canada’s financial institutions have not come under stress and are well positioned to handle higher credit losses in the future.
“The country’s financial system has faced unprecedented shocks in recent years, and it has proven resilient,” Bank of Canada governor Tiff Macklem said in a press conference Thursday, citing the pandemic and the subsequent rise in inflation and interest rates.
“Now the Canadian economy and financial system face a new threat,” he said. “U.S. trade policy has taken a dramatic protectionist shift. Tariffs and uncertainty have sharply reduced prospects for global economic growth. And financial markets have been rocked by chaotic policy announcements and reversals.”
The governor said central bankers have two key worries when it comes to Canadians’ future financial stability.
He warned that a prolonged trade war would reduce economic growth and increase unemployment, putting pressure on Canada’s financial system and causing banks to cut back lending. This, in turn, would create greater financial stress for Canadians.
The bank highlighted that a severe and long-lasting trade war could push the rate of mortgage arrears — or late mortgage payments — beyond levels reached in the 2008 global financial crisis, but Macklem called this a “pretty extreme scenario.”
“While that’s not the central bank’s base case forecast, it’s a reminder of the urgency with which Canadian officials must address the trade spat with the U.S.,” Royce Mendes, economist at Desjardins, wrote in a note to clients.
At the same time, the bank is increasingly concerned that Trump’s trade war will trigger a “disorderly” market sell-off in the near-term, harming Canadian households and amplifying the risk of an economic slowdown.
The report cited recent bouts of “extreme market volatility,” particularly when investors dumped stocks and traditionally stable U.S. government bonds following Trump’s announcement of global “reciprocal” tariffs on April 2.
“Government bond markets are the foundation of the financial system. They need to function smoothly for other markets to work,” said the central bank’s senior deputy governor Carolyn Rogers in prepared remarks.
“If the trade war causes a larger spike in volatility than we have seen so far, leveraged hedge funds might rush to sell their holdings. That could strain liquidity across core markets, increasing stress throughout the financial system,” she added.
The bank said it is monitoring signs of financial stress and is working closely with federal and provincial financial authorities to address potential emerging issues.
“We must remain vigilant. Vulnerabilities remain and there is a another test on the horizon,” said Rogers.
