MNI BOC WATCH: 25BP Trade-War Cut, Caution About Further Moves
MNI (OTTAWA) - The Bank of Canada said dangers from a U.S. trade war led it to cut borrowing costs for a seventh consecutive meeting Wednesday, continuing to lead the G7 on stimulus, and expressed caution about further moves as the immediate hit to growth may be followed by unwelcome 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," Governor Tiff Macklem said in a statement. "We’re now facing a new crisis. Depending on the extent and duration of new U.S. tariffs, the economic impact could be severe. The uncertainty alone is already causing harm."
The Bank's target rate on overnight loans between commercial banks was lowered to 2.75% from 3%, and has come down from 5% in June. Most economists predicted the decision and expect further relief if Donald Trump continues a trade war unseen since the 1930s between two of the world's largest trade partners.
"Monetary policy cannot offset the impacts of a trade war. What it can and must do is ensure that higher prices do not lead to ongoing inflation. The focus of Governing Council 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," Macklem said.
Trump's tariff threats will contributing to dragging down first-quarter growth by hurting sentiment and activity, the Bank said. It's also "imperative" to keep longer-term price expectations in check, with headline inflation close to 2% and core prices running above that mark, officials said.
"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," the Bank's rate decision said. Stockpiling of goods ahead of U.S. tariffs may turn from a boost to Canada's exports in the first quarter to a further drag on growth in the second quarter, the Bank said.
Canada sends three-quarters of its exports to the U.S., and those suppliers account for one in ten jobs. Bank officials last month laid out a scenario where exports would fall 8.5% and investment 12% in the first year of a dispute while a weaker Canadian dollar only partly offsets that weakness while boosting import prices.
Former Governor Stephen Poloz has said a trade war could bring a 20% depreciation in Canada's dollar, though Macklem has suggested he's far from the limit of how far he can diverge from the Fed. Today's quarter-point cut takes the gap between Canada’s policy rate and the bottom of the Fed’s target range to 150bps, the widest since 1997. The gap was 250bps that year, a record under the BOC’s inflation targeting regime.
With Prime Minister Justin Trudeau resigning soon in favor of former BOC and BOE Governor Mark Carney, it's unclear how much fiscal policy will fill any dip in demand. Carney himself will face an election in coming weeks or months, either calling a snap election himself or because Liberals face a non-confidence motion soon after Parliament re-opens March 24. Other structural challenges include a shift to curtail record immigration and stagnant productivity.
While core inflation is above 2% the Bank is fortunate that headline prices have been brought back to the 2% target in recent months, giving the full flexibility of its 1% to 3% target band. The key rate is now also in the middle of the Bank’s estimated neutral range of between 3.25% and 2.25%.