Ongoing trade tensions with the U.S. could lead to lower growth and higher prices in the Canadian economy, according to one economist, potentially causing the Bank of Canada to move interest rates lower than it otherwise might have.
Ottawa moved forward Wednesday with reciprocal dollar-for-dollar tariffs on U.S. steel and aluminum, responding to U.S. President Donald Trump’s 25 per cent tariffs on steel and aluminum imports that came into effect that same day. The Bank of Canada also moved to lower its key policy rate by 25 basis points to 2.75 per cent, with Governor Tiff Macklem saying signs of stability are at risk given the trade war.
“We’re getting increasing evidence within the surveys that all of this tariff volatility is increasing uncertainty and it’s reducing sentiment. When it’s very uncostly to wait to delay hiring decisions, to delay investment, we think that’s going to have an increasing impact on both the United States and Canada,” Tiffany Wilding, a managing director and North American economist PIMCO, said in an interview with BNN Bloomberg Wednesday.
“I think you saw that coming out very clearly in the Bank of Canada statements this morning. Against that though, there will be some price level adjustments that will happen as companies try to pass some of these additional costs through. We’re basically coming to a system with lower potential growth and a higher price level as a result of all of this.”
Along with its interest rate announcement, Canada’s central bank provided an update on how Canadian businesses and households are reacting to the trade conflict with the U.S. It said that businesses and households are viewing the current climate as “unpredictable” given continued changes in the timing, scope and magnitude of tariffs.
The changes are presenting difficulties for Canadian businesses looking to set prices or make investment or hiring decisions, according to the central bank. For households, the changes are spurring fears about job security and financial health, leading to intentions to reduce spending.
Wilding said that outside of trade-related downside risks, a 2.5 per cent policy rate “seems like a reasonable level for where they would get and stay.”
“But I think there’s certainly some downside risks to that to the extent that you have tariffs that are more damaging, I think the risk is certainly they go below that and need to accommodate as a result,” she said.
Given the economic challenges trade tensions could cause on both sides of the border, Bipan Raj, the head of ETF and structured solutions strategy at BMO Global Asset Management, said he is surprised “to a degree” regarding the economic damage Trump appears to be willing to cause.
“This is a long-standing trade relationship between the two countries that has been integral to the fundamental structure of each economy,” he said.
“In this sort of environment, where we’re heading into a meaningful trade shock. It it does surprise us to a significant degree that we’re willing to inflict these economic wounds on ourselves.”
‘Adjustment of a different kind’
Philip Petursson, chief investment strategist at IG Wealth Management, said in a statement to BNNBloomberg.ca Wednesday that while the rate cut from the central bank was “widely expected” it was “policy adjustment of a different kind.”
“This was not a cut because of moderating inflation. Nor was it a cut to support a faltering economy,” Petursson said.
He highlighted Macklem addressed strength in the economy and labour market during the announcement.
“This cut was a direct response to the recently announced tariffs by (U.S.) President Trump. And while a reduction in the overnight rate won’t solve the challenges brought about by tariffs, the Bank sees it as its mandate to do what it can to offset the economic impact,” Petursson said.
Regarding the path of interest rates, he said it will depend on how long tariffs remain in place.
“The longer the tariffs remain, the greater the potential damage to the Canadian economy, the lower the overnight rate is likely to go,” Petursson said.
‘Imbalances’
As trade tensions continue, Raj said it’s important to pay attention to “imbalances” in the Canadian economy. He said some of these imbalances include the “inordinate” amount of debt among Canadian households and mortgages likely to be refinanced at higher rates over the next few years.
“If we look at direct trade with the United States, 10 per cent of the labour force is subject to that, and then that expands even more once we consider indirect trade with the United States,” he said.
“Unfortunately, we could be in a scenario where the unemployment rate does tick up and then all of a sudden those imbalances that I talked about including the amount of household debt we’re sitting on…That comes into sharper relief as more and more households start to prioritize deleveraging and really at the expense of discretionary spending.”
