Bank of Canada prepares for a trade war

Nonetheless, given the uncertain outlook for tariffs with the US, the BoC also stated that “the scope and duration of a possible trade conflict are impossible to predict” and so its baseline assumption for its forecasts assumes no new tariffs. If there is no threat of tariffs, it believes that “the upside and downside risks around the outlook are reasonably balanced”. In this environment, it assessed that “the economy is expected to strengthen gradually and inflation to stay close to target”. This hints that we are probably at or close to the bottom for interest rates.

However, we argue that the risks for the Canadian economy remain skewed to the downside. Household debt remains very high by international standards and the structure of Canada’s mortgage market means that many households are yet to feel relief from lower rates. But the biggest concern is President Donald Trump’s threat of 25% tariffs on imports from Canada into the US from as soon as 1 February – this weekend!

It is of huge concern to business leaders and politicians alike. The US is by far and away Canada’s most important trading partner, taking in 76% of Canada’s exports with the value equivalent to around 20% of Canadian GDP. The proposed tariffs will undoubtedly hurt the competitiveness of Canadian products, with a clear risk that substitution away from Canadian-sourced items leads to an economic downturn and potential recession.

In an environment where the BoC has talked about excess spare capacity, the risks that the BoC cuts the overnight rate below 2.75% – our current forecast for the bottom – are high. As discussed by Governor Tiff Macklem at today’s press conference, should the negative growth impact of a trade war come in faster on more forcefully than the upward effect on inflation, the BoC can ease further.