MNI BOC WATCH: Ready To Adjust To Trade War After 25BP Cut
MNI (OTTAWA) - The Bank of Canada's 25bp interest-rate cut Wednesday was littered with 28 references to dangers of a trade war with Donald Trump and policymakers stand ready to help the economy adjust by keeping inflation on target if tariffs "badly hurt" output and "put direct upward pressure" on prices.
"If broad-based and significant tariffs were imposed, the resilience of Canada’s economy would be tested," Governor Tiff Macklem and deputies said in the decision from Ottawa. "As we consider our monetary policy response, we will need to carefully assess the downward pressure on inflation from weakness in the economy, and weigh that against the upward pressure on inflation from higher input prices and supply chain disruptions," Macklem said in a statement for a press conference due at 1030am EST.
The Bank's sixth consecutive cut to 3% slowed the pace to a quarter point after two prior half-point moves, but the language aligns with experts who have told MNI Macklem will return to a jumbo move in a trade war. Figuring out how Canada fares in that fight is tough because two of the world's largest trade partners have almost never contemplated such large penalties, and the BOC also said it can only help with adjustment rather than resolve all the risks.
Staff analysis suggested the effects would be lopsided with Canada's growth rate slashed 2.5% in the first year of a trade war. That's greater than the Bank's estimate for 1.8% GDP growth this year, though they did not use the word recession. Inflation in the first year would see a weaker economy and falling commodity prices largely offsetting inflation from tariffs.
References to the policy rate nearing neutral were left out of the decision while officials repeated they have delivered a lot of easing that is boosting growth as inflation settles back on the 2% target. That means "monetary policy is better positioned to help the economy adjust to new developments" the Bank said. Officials also said they will pay close attention to how the U.S. and Canada adjust to higher import prices resulting from tariffs.
Another way inflation can be lifted in Canada is a weaker currency and the Bank noted trade tensions there too, saying "The Canadian dollar has depreciated materially against the US dollar, largely reflecting trade uncertainty and broader strength in the US currency." Trump pushed back his threat of a blanket 25% tariff from his first day in office to Feb. 1 and Canada has signaled dollar-for-dollar retaliation. Canada sends three-quarters of its export to the U.S.
Excluding a trade war the Bank signaled the economy has settled down from an era where inflation surged to 8%. Growth is picking up and will run faster than the economy's potential, eating away at slack over the next two years. That's a switch with the government curbing record immigration that saw per-person GDP fade over much of the last two years.
Twenty of 23 economists predicted Wednesday's rate cut with the rest seeing potential for a pause or a half-point move. Economists had also seen the rate falling to about 2.5% by the middle of this year, a bit below the Bank’s estimated neutral rate.
Outsized rate cuts remain unusual. Since the fixed announcement system began in 2000, the Bank hasn’t made multiple 50bp reductions outside of the pandemic, the global financial crisis or 2001 terrorist attacks.
The Bank also unexpectedly announced QT will end in March, with the start of gradual term repo purchases and treasury bills later this year. The Bank's deposit rate starting Thursday will be set 5bps below the policy rate, a move aimed at improving the implementation of monetary policy.