Bank of Canada Governor Tiff Macklem warned that a full-blown trade war with the United States would permanently weaken the Canadian economy and cautioned that the central bank has few tools to respond to a structural shift toward protectionism that would both hamper growth and increase inflation.
He also said that now is not the right time for the central bank to change its 2-per-cent inflation target, even as it embarks on a five-year review of its monetary policy mandate.
“In the pandemic, we had a steep recession followed by a rapid recovery as the economy reopened. This time, if tariffs are long-lasting and broad-based, there won’t be a bounce-back,” Mr. Macklem said in a speech on Friday in Mississauga. “We may eventually regain our current rate of growth, but the level of output would be permanently lower. It’s more than a shock; it’s a structural change.”
Since returning to the White House, U.S. President Donald Trump has threatened to impose a 25-per-cent tariff on imports from Canada, with lower levies on energy products, although he delayed implementation until March 4. He has also announced 25-per-cent tariffs on steel and aluminum that take effect on March 12, and threatened additional tariffs on cars, lumber and other products.
A trade war would put the Bank of Canada in a difficult position. Widespread tariffs would likely push Canada’s fragile economy into a recession. But a trade conflict would also increase consumer prices in Canada, as Ottawa retaliated with its own tariffs, the loonie depreciated against the greenback and businesses rejigged supply chains.
That would force the central bank to choose between cutting interest rates to support growth and employment, and raising interest rates – or at least holding them steady – to keep inflation in check and prevent a one-time jump in prices from becoming entrenched in consumer and business psychology.
“Provided the inflationary impact of tariffs is not too big, monetary policy can help smooth the adjustment by supporting demand so it doesn’t weaken too much more than supply. But how much support monetary policy can provide is constrained by the need to control inflation,” Mr. Macklem said.
He suggested the aggressive monetary-policy-easing the bank delivered during the COVID-19 pandemic – cutting interest rates to near zero and buying hundreds of billions of dollars worth of government bonds to suppress interest rates – wouldn’t be appropriate this time around. “We can’t let a tariff problem become an inflation problem,” he said.
Inflation has fallen sharply over the past two years and is currently running below the bank’s 2-per-cent target, coming in at an annual rate of 1.9 per cent in January. That has allowed the central bank to cut interest rates at six consecutive meetings, bringing its benchmark policy rate to 3 per cent last month.
After the speech, financial markets put the odds of another rate cut at the bank’s next rate decision on March 12 at around 40 per cent, according to LSEG data. Looking further ahead, investors are pricing in two more cuts before the end of 2025.
“Macklem’s comments are consistent with our view that the Bank of Canada would cut rates roughly 50 to 100 basis points more than otherwise if 25-per-cent U.S. tariffs materialize,” Royce Mendes, head of macro strategy at Desjardins, wrote in a note to clients. (A basis point is 1/100th of a percentage point).
Mr. Mendes added that he expects the bank to hold rates steady next month, then continue cutting in April, “whether or not tariffs are introduced by then, given the domestic population and mortgage challenges facing the Canadian economy.”
Mr. Macklem outlined new Bank of Canada modelling on the potential impact of Mr. Trump’s threat to impose a 25-per-cent tariff on Canadian imports, along with a lower 10-per-cent tariff on energy, together with retaliation from Canada.
In this scenario – which Mr. Macklem emphasized is not a forecast – Canada’s exports would fall by 8.5 per cent, consumer spending would contract by more than 2 per cent by 2027 and business investment in the country would decline by almost 12 per cent by early 2026.
“In our January projection with no tariffs, we forecast growth of about 1.8 per cent in both 2025 and 2026. But in the tariff scenario, the level of Canadian output falls almost 3 per cent over two years. That implies tariffs would all but wipe out growth in the economy for those two years,” Mr. Macklem said.
Worryingly, a major trade war would leave the Canadian economy on a permanently weaker footing. Even if the rate of growth rebounded, economic output would remain 2.5 per cent lower than a no-tariff scenario, Mr. Macklem said.
With the central bank constrained in how it could respond to a tariff-induced recession, Mr. Macklem suggested that governments at every level in Canada need to step up and do more to drive growth. That means removing rules that restrict interprovincial trade, speeding up timelines for regulatory approvals and improving east-west transportation links to help get Canadian products to overseas markets.
Mr. Macklem also used the speech to outline priorities for the coming Bank of Canada mandate review with the federal government, which takes place every five years and will be finalized next year. In the past, the bank has looked at whether its 2-per-cent inflation target should be changed. Mr. Macklem said he did not favour reopening this debate this time around. “In my view, now is not the time to question the anchor that has proven so effective in achieving price stability,” he said.
But he said the bank will be looking at a range of issues, including how monetary policy interacts with Canada’s unaffordable housing market, whether the bank needs a “richer playbook” to deal with supply-side shocks and whether it should use a broader range of inflation indicators.
