Bank of Canada Continues to Provide Measured Rate Relief Amid High Uncertainty over Growth, Inflation Triggered by Trade War

–BOC Trims Policy Rate By 25 Basis Points To 2.75% in 7th Straight Rate Cut as Widely Expected
–Governor Macklem: Governing Council Will Proceed ‘Carefully’ with Any Further Changes to Policy Rate
–Macklem: Council Didn’t Seriously Consider 50-Basis Point Cut Due to Uncertainty Over When and How Much Trade War Will Boost Prices
–BOC Surveys: Threats of New Tariffs, Uncertainty Over Canada-US Trade Already Having ‘Big Impact’ on Business, Consumer Intentions

By Max Sato

(MaceNews) – The Bank of Canada on Wednesday trimmed its policy interest rate – the target for overnight lending rates – by another 25 basis points to 2.75% as widely expected, conducting its seventh straight rate cut, first to ease the pain of high borrowing costs caused by its own credit tightening and more recently to help cushion the drag from a global trade war launched by the Trump administration.

The latest decision follows a moderate pace of a 25-basis point reduction in January and two consecutive 50-basis point slashes, in December and October, and three 25-basis point cuts since June when the bank began unwinding the effects of its past aggressive tightening.

The bank has now delivered a total 225 basis points (2.25 percentage points) in credit easing. It raised the policy rate by a total of 475 basis points between March 2022 and July 2023, jacking up the key rate through 10 increases from its record low of 0.25% to a 22-year high of 5.0%.

Governor Tiff Macklem told a news conference that the six-member Governing Council “did not seriously consider a cut of 50 basis points” because there is so much uncertainty over whether inflation will stay around the bank’s 2% stability target in the coming months amid the “fluid” trade conflict situation.

To stay “forward-looking” in setting interest rates, the governor said, bank officials are monitoring both the hard data that has not yet shown any serious damage from the trade war and the latest anecdotal evidence in surveys that indicated consumer and business confidence has been hard hit.

“The trade war weakens growth but it will also increase prices and inflation,” he said. “We’ve got to be very careful to balance those two. Against that background, we did not want to get ahead of ourselves.”

During the briefing, Macklem repeatedly said the bank does not target exchange rates but that they are set in the currency markets, reflect what is going on and somehow work as a shock absorber (when the currency weakens by supporting exporter profits), although the recent depreciation of the Canadian dollar could push up import costs.

“It (the Canadian dollar) has depreciated and that largely reflects the continued threats by the U.S. administration of significant tariffs,” he said.

The governor also told reporters that the trade conflict with the United States can be expected to weigh on economic activity, while also increasing prices and inflation.

“Governing Council will proceed carefully with any further changes to our policy rate given the need to assess both the upward pressures on inflation from higher costs and the downward pressures from weaker demand,” he said.

He also said the focus of the bank’s rate-setting panel “will be on assessing the timing and strength of both the downward pressure on inflation from a weaker economy and the upward pressure from higher costs.”

Based on the bank’s annual estimate about where the Canadian neutral interest rate likely lies, the current policy rate level sits in a range of 2.25% to 3.25% that is roughly considered to be neutral to economic activity, the governor said. The bank will provide its latest estimate in its next policy announcement on April 16.

Macklem didn’t give a direct answer to the question as to whether the “careful” approach to the upcoming rate decisions in April, June and July onward could mean a rate hike is possible.

Instead, he said, “The reality is there’s a lot of uncertainty. And against that background we can’t provide forward guidance.” 

“We’ve been very clear that monetary policy cannot offset the impact of the trade war,” he continued. “We are going to get weaker economic activity, we are going to get higher prices, higher inflation. We can’t change that. What we can do is to ensure that any rise in inflation is temporary.”

Central bank policymakers will do as much as they can to help the economy cope with the “painful adjustment” to higher U.S. tariffs on imports from Canada and the rest of the world. “But what we can do is limited by the need to control inflation: We can’t lean against weaker growth and higher inflation at the same time,” he added.

In his statement and news conference, the governor stressed the need to ensure that Canadians believe price increases will be manageable in about 18 months and beyond despite the threat of another spike in inflation, most recently triggered by the global supply chain breakdowns during the pandemic and Russia’s invasion of Ukraine.

“It’s going to be critically important that medium- and longer-term inflation expectations will remain well anchored,” he said. “When that happens, any increase in inflation will be temporary and inflation will come back to target.”

On the question of what inflationary impact the trade war is likely to have, the governor replied that it is forcing firms to seek new suppliers, hold extra inventories and look for new markets, and that those new costs will be eventually passed onto consumers but its timing and scale is unclear.

“Some prices are going to go up. We can’t change that,” he said. “What we don’t want to see is that the first round of price increases have knock-on effects, causing other prices to go up, that becoming generalized in ongoing inflation. That we can’t let happen.”

Quoting the preliminary results of the bank’s quarterly surveys on businesses and households released Wednesday, the governor said, “While it is too early to see much impact of new tariffs on economic activity, our surveys suggest that threats of new tariffs and uncertainty about the Canada-U.S. trade relationship are already having a big impact on business and consumer intentions.”

The recent shift in consumer and business intentions is expected to translate into a marked slowing in domestic demand in the first quarter of this year. At the same time, merchandise trade data suggest businesses on both sides of the Canadian border have stocked up on imports in advance of tariffs.

“As a result, Canadian exports and imports are both expected to be stronger in the first quarter,” Macklem said. “But the impact on exports looks to be bigger, which should provide some offset to weaker domestic demand in the quarter.”

“Of course, this pull-forward in exports likely means weakness ahead,” he predicted. “If household and business spending intentions remain restrained, the combination of weaker exports and soft domestic demand would weigh further on economic activity in the second quarter.”  

The Canadian economy ended 2024 on a stronger footing than projected by the BOC. Past interest rate cuts have boosted consumer spending and business investment, increasing domestic demand in the fourth quarter by a robust 5.6%. Overall, GDP grew 2.6% in the fourth quarter after upwardly revised growth of 2.2% in the third quarter.

This growth path is considerably stronger than bank officials expected based on the information they had in January.

Inflation has remained close to the 2% target. The temporary two-month sales tax break by the Canadian government has lowered some consumer prices, but January inflation came in a little firmer than expected at 1.9%. Inflation is forecast by the bank to increase to about 2.5% in March after the tax break ended on Feb. 15.