Bank of Canada to Cut as Tariffs Strike Economy

The Bank of Canada is expected to lower interest rates for the seventh time on Wednesday as the country braces for a trade war that, if not resolved quickly, will drive the economy into a recession.

Economists and markets predict policymakers, led by Governor Tiff Macklem, to lower the policy interest rate to 2.75%, the lowest level since September 2022.

The uncertainty created by US President Donald Trump’s tariffs will force the central bank to continue reducing to mitigate economic harm. Without the trade war, a stronger-than-expected recovery in the Canadian economy and hints of higher core inflation may have justified a pause in the easing cycle.

“Based on recent data alone, I wouldn’t have thought they’d be cutting at this meeting,” said Veronica Clark, an economist at Citigroup, via email. “But that data feels pretty stale now and won’t reflect current conditions of tariffs.”

Last week, Trump placed 25% tariffs on most Canadian and Mexican imports but then promised a one-month wait for those who adhere to the North American trade pact. He then threatened significant additional levies on Canadian timber and dairy. The United States also imposed 25% import levies on steel and aluminum, affecting two major Canadian export industries; the president temporarily threatened to raise those duties to 50%.

Canada has retaliated, putting levies on C$30 billion ($20.8 billion) in US goods and pledging to expand tariffs to C$155 billion worth of products on April 2 unless the White House backs down or the sides can negotiate a way out.

The central bank’s task amid the rapidly changing trade dynamic is to keep communicating that it can adjust interest rates to lessen the economic hit.

Still, Macklem is likely to reiterate there’s a limit to how much monetary policy can do to fix the problem. The tariff battle will come with an inflation shock, constraining the bank’s response compared with the COVID-19 pandemic, when the policy rate fell to 0.25%.

Economists believe that Trump’s tariffs on Canada and retaliation will cut 2 to 4 percentage points off the country’s GDP growth.

The central bank anticipates comparable economic suffering. In a speech last month, Macklem stated that a prolonged trade war would kill growth and reduce Canada’s production by about 3% over two years. Still, the bank projected that the forces driving prices up would exceed downward pressures on prices, leading inflation to rise.

And, while the central bank has downplayed the recent increase in underlying price pressures, core inflation averaged 2.7% in January and has remained at that level for months, adding to concerns.

The trade uncertainty contrasts sharply with Canada’s strong domestic indicators. At the end of last year, economic growth surged to a 2.6% annualized pace, boosted by household spending and housing increases, both interest-sensitive sectors that have benefited from the rate reduction.

Relief of Pain:

In January, Macklem stated that monetary policy cannot heal the harm created by a trade war. Instead, he saw the central bank’s function as reducing the impact of the economic shock and smoothing the adjustment process.

“The bank’s role is to look beyond the next month or two. It can’t rebuild a closed plant with a few rate cuts. Still, it can boost domestic demand to compensate,” noted Avery Shenfeld, chief economist of Canada Imperial Bank of Commerce, in a report to investors.

Policymakers began lowering borrowing costs from 5% in June when the bank saw adequate evidence that inflation had been controlled, which had fallen to the 2% objective in the third quarter of 2024.

Though the central bank did not provide any particular rate advice at its January meeting, a record of deliberations revealed that policymakers chose to lighten in part due to the growing uncertainty created by Trump’s tariff threats.

The entire scope of Canada’s retaliatory tariffs has yet to be applied, and the loonie, while weak, has not dropped as much against the dollar as it could if the trade war continues. These variables might hamper the central bank’s reaction.

A quarter-percentage-point decrease this week would place borrowing costs in the center of the so-called neutral band, which is a notional level of interest rates that does not hinder or boost the economy. Markets and experts believe the central bank will slash rates to as low as 2% this year.