February 13, 2025
If a new round of tariffs ever comes into play, they could force the Bank of Canada to set aside its inflation mandate to protect the country’s growth, say several prominent economists.
“Markets expect (and we agree) that the economic growth risks from higher tariffs would offset any potential mechanical impacts on inflation from Canada’s retaliatory measures,” economists at Royal Bank of Canada said in a note on Thursday.
It’s uncomfortable territory for policymakers, given that the Bank of Canada’s mandate is to set monetary policy that achieves price stability and maintains inflation at or near its target of two per cent.
But economists think the fallout from the tariffs floated by United States President Donald Trump and the retaliation already laid out by Canada will be so significant that it will outweigh any damage caused by inflation as prices spike on the rising cost of imports and the falling value of the Canadian dollar.
Economists at CIBC Capital Markets said gross domestic product (GDP) could fall five per cent if the full magnitude of the tariffs is imposed and are “long lasting.” Inflation could rise to the top of the Bank of Canada’s target range, which is three per cent.
“In a lasting trade war scenario, downside risks to growth would trump what would be temporary and soon-reversed upside risks to inflation,” chief economist Avery Shenfeld and senior economist Ali Jaffery said in a note.
Despite the dramatic turn of events on Monday, when the deadline to impose duties was pushed back to March 4, Nick Rees, head of macro research at currency trader Monex Europe Ltd., thinks tariffs are still coming.
“The suspension of some initial tariff measures should not be taken as indicative of the likely direction of travel,” he said, citing Trump’s need for revenue to fund corporate and personal tax cuts and his goal of returning manufacturing to the U.S.
Where does this leave the Bank of Canada?
Economists say it will have no choice but to cut interest rates further to bolster growth, even if tariff-induced inflation rears its head.
At the central bank’s meeting on Jan. 29, when it reduced rates by 25 basis points to three per cent, governor Tiff Macklem acknowledged the danger tariffs pose.
“This is a complex shock for monetary policy because growth will be weaker, inflation will be higher,” he said during a press conference in Ottawa. “We are going to be assessing the relative weight of those two.”
In a departure from previous Bank of Canada meetings, Macklem provided no guidance on the future path of rates, leaving some economists to forecast that an interest rate hold was likely at the next policy meeting on March 12.
Prior to Monday’s reprieve, CIBC was calling for rates to come down to 2.25 per cent in the second quarter from their current level of three per cent, while “expecting fiscal policy to play a helping hand,” Shenfeld and Jaffery said.
Without tariffs, RBC was forecasting for the Bank of Canada to cut rates to two per cent by year-end. But if U.S. tariffs and Canada’s retaliation materialize, RBC thinks policymakers will have to go even lower.
“Sustained (lasting more than weeks) tariff hikes will likely push the (Bank of Canada) to cut rates more aggressively than we currently expect,” RBC Economics said. “Although, as we’ve discussed, the expected duration of tariffs and the extent of fiscal responses from provincial and federal governments would determine the ultimate size and speed of further cutting.”
Canadian exporters’ dependence on the U.S. is not new, and it can be explained by a variety of factors, such as proximity to market, a shared language, similar legal systems and a long, fruitful history of free trade.
Within the seeds of a momentarily dormant trade conflict, but with four more years of Trump volatility on deck, is an opportunity for Canadian businesses to calmly take stock of the situation, do some creative thinking and execute a response with future profits and potential new markets in mind. — Joe O’Connor, Financial Post
