Seven down

As expected, the Bank of Canada trimmed its policy rate by 0.25 percentage points to 2.75%—the seventh consecutive rate cut.

Setting monetary policy during a trade war poses a bit of a conundrum for the Bank. Tariffs and countertariffs raise prices. But they also slow the economy, which puts downward pressure on inflation.

The Bank put more emphasis on the latter today. A wise choice in our view, and something we called last week.

Staying ahead of the curve

Why cut? There are two main reasons. Inflation is already running at the 2% target and recession risks have sharply increased.

The Canadian economy entered this latest tariff spat in a weakened state with unemployment at 6.6% and GDP per capita trending lower (until recently).

However, the Bank notes that the economy has shown signs of life as of late, and growth in the second half of 2024 has exceeded their expectations. That is, monetary policy is working to help fix the old problems (the battle against inflation), but now we have new problems (a trade war).

From the statement:

“While past interest rate cuts have boosted demand for labour in recent months, there are warning signs that heightened trade tensions could disrupt the recovery in the jobs market.”

In short, the Bank of Canada is getting in front of this new trade war by injecting more monetary stimulus. The Bank released survey data showing business intentions to invest and consumer spending intentions have declined due to these trade tensions.

But what about inflation? The Bank of Canada seems content to look past an increase in inflation as long as it’s temporary and inflation expectations don’t get out of hand. Temporary is the key word. From the press conference:

“Keeping medium- and longer-term inflation expectations well anchored is imperative to ensure any rise in inflation is temporary [emphasis ours].”

The Bank’s survey data suggest short-term inflation expectations (1-2 years) have increased, but longer-term expectations (2 years+) have encouragingly held fairly steady.

If this continues… slower growth and higher inflation

Inflation has faded, but there are still some warning signs.

Core inflation has proved more stubbornly high on the way down, and the Bank of Canada notes headline inflation will tick higher to around 2.5% post GST/HST holiday.

On the other hand, we’d also note that shelter—a major driver of inflation—has relaxed in recent months. With population growth slowing, and housing supply slowly catching up, we see less pressure coming from the shelter component.

No new forecasts were released—this was just a rate announcement; hence, we are left gleaning over every word in the statement and press remarks.

But we only need to go back to the January Monetary Policy Report and a speech in February to get a flavour for what the BofC thinks will happen if this continues.

In updated analysis released February 21, the Bank said the tariffs in Trump’s Executive Order signed February 1, along with countertariffs, would reduce real GDP by 2.9% by mid 2027 relative to the base case. Output would be about 2.5% permanently lower, if tariffs persist.

To be clear (and economists are not always clear on this point), this is a reduction from the base case, not an outright decline. That is, under the Bank’s trade war impacts, we would see no to very modest growth under this scenario relative to the Bank’s base case (no tariff) forecasts of 1.8% in 2025 and 2026.

What’s next?  More cuts in our view

The Bank talks about a wait and see approach.

“Governing Council will be carefully assessing the timing and strength of both the downward pressures on inflation from a weaker economy and the upward pressures on inflation from higher costs.”

We think the Bank will put more emphasis on the downside risks to growth, and we don’t think the Bank of Canada is done cutting.

Like everything else, it depends on how long the trade war lasts.  If this trade war continues or escalates, we could see the BofC near 2% by mid-year and 1.5% by 2026 before holding. If trade tensions ease, we see the rate settling in at 2.5% by mid year and holding (our old non-tariff forecast).

A blunt instrument:  “Monetary policy can’t do everything”

Monetary policy can help in this trade war, but it can’t save the day. This is something Governor Macklem has been talking about in recent speeches, and reiterated today.

On February 6, Macklem had this to say:

“But monetary policy can’t do everything. We need to avoid the temptation to overload monetary policy by expecting more of it than it can deliver. The right focus for monetary policy is on what it can do.”

Today, he said: “Monetary policy cannot offset the impacts of a trade war.”

In other words, after slashing the policy rate by 2.25 percentage points from the recent 5% peak, other levers that the Bank doesn’t have access to will need to be pulled.

The fiscal policy lever could include targeted relief for impacted businesses and employees and infrastructure investments. In particular, this would be an opportune time in our view to build  transportation infrastructure, with the double hit of job creation and improving access to new markets.

More broadly, we can’t think of a better time to pull Canada out of its productivity funk and boost growth by removing interprovincial trade barriers, fast-tracking major projects, and improving access to international markets.

In other news… more tariffs

Meanwhile, U.S. tariffs on Canadian steel and aluminum took effect today. See our comments on what this might mean for Alberta here. The tariffs will disproportionately hit Quebec and Ontario, Canada’s major primary producers of raw aluminum and steel, respectively. Alberta’s main impact will come mainly through secondary effects on construction and related metal manufacturing.

Steel and aluminum tariffs will also hurt U.S. manufacturers, as costs increase. The U.S. is heavily reliant on Canada for these products (especially aluminum), with few immediate substitutes.

Answer to the previous trivia question: The unofficial slogan of the state of Missouri is "Show-Me."

Today’s trivia question: What is the atomic number of aluminum on the periodic table of elements?