The Bank of Canada is anticipated to reduce interest rates for the seventh time on Wednesday amid economic challenges tied to trade tensions with the U.S. The move comes as Canadian businesses and households face uncertainty due to the U.S. administration’s trade policies.
In January, the Central Bank cut its benchmark interest rate by 0.25 points, bringing it to 3 per cent. This decision was intended to provide a buffer against the potential impacts of escalating trade conflicts. Since then, tariffs imposed by the U.S. have caused trade disruptions, creating challenges for Canadian businesses.
Bank of Canada Governor Tiff Macklem has emphasized that monetary policy is limited in addressing trade issues. Tariffs can slow economic growth and raise unemployment, while also increasing prices. This puts the central Bank in a difficult position, balancing economic support with controlling inflation.
Given current conditions, many experts believe the Bank will prioritize recession risks over inflation concerns. As Canada implements retaliatory tariffs and the Canadian dollar depreciates, the effects on businesses are significant.
Avery Shenfeld, chidepreciatesIBC, told the Globe and Mail that while inflation may spike briefly, it will unlikely lead to sustained wage or price increases amid an economic slowdown and reduced consumer spending.
Market data indicates an 80 percent likelihood of a 0.25 percentage point rate cut this week, which would bring the key rate to 2.75 percent. This aligns with the Bank’s neutral range, where interest rates neither restrain nor support the economy.
Despite the series of cuts since last summer, some experts argue that without the trade tensions, the Bank might have paused its easing cycle.
Labour Market Strain
Inflation levels have been near the Bank’s 2 percent target in recent months. However, core inflation figures, which strip out short-term fluctuations, sit near the higher end of the Bank’s percentage range.
Temporary factors have also influenced inflation metrics, such as the federal GST holiday earlier this year.
Economic growth in Canada has shown stronger-than-expected results. In the final quarter of 2024, GDP expanded at an annualized rate of 2.6 per cent, surpassing forecasts. Labour market data, however, revealed signs of strain in February, with only 1,100 jobs added and unemployment steady at 6.6 per cent. These numbers follow months of robust employment growth, but prospects remain uncertain.
U.S. trade policies continue to weigh heavily on Canada’s economy. While some tariffs have been temporarily eased under the United States-Mexico-Canada Agreement (USMCA), additional threats remain.
Steel, aluminum, lumber, dairy, and other industries face significant challenges with new tariffs looming. For example, 25 percent tariffs on steel and aluminum imports are set to take effect on the same day as the Bank’s rate announcement.
Investments in Canada
The uncertainty around trade policies has already led many Canadian companies to scale back production or reduce their workforce. A recent KPMG survey revealed that over half of export-focused businesses had taken such steps in anticipation of tariffs.
Royce Mendes, head of macro strategy at Desjardins, pointed out that this environment discourages new investments in Canada, and the long-term economic impact could be substantial.
Governor Macklem has warned that heightened tariffs could lead to a recession. Central bank projections suggest a prolonged trade conflict could result in an 8.5 percent drop in exports, a 12 percent decline in business investments, and a 2 percent reduction in consumer spending. Together, these factors could shrink Canada’s economic output by 3 percent over the next two years compared to a non-tariff scenario.
While the federal and provincial governments may take the lead in offering financial relief to affected businesses and workers, the Bank of Canada is expected to continue supporting the economy.
Governor Macklem has stated that monetary policy can help cushion the impact by encouraging demand, provided inflationary pressures remain manageable.
