MNI:BOC-Some Rate Cuts May Help If Trade War Stalls GDP For 2Y
MNI (OTTAWA) - Canada's central bank said its has some room to lower interest rates in a U.S. trade war that would stall economic growth for two years, with officials mindful of ensuring that a boost of inflation above the target remains temporary.
"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," Governor Tiff Macklem said in the text of a speech he's giving Friday in Toronto. A media summary of the speech elaborated that "Lower interest rates could help support demand during this period" alongside the same caution about the 2% inflation target.
Predicting damage from a trade war is difficult because the scale of tariffs proposed by U.S. President Donald Trump hasn't been seen since the 1930s, Macklem said. Staff scenarios were updated from the Bank's January forecast to include Trump's call for 25% tariffs on all goods from Canada except for a 10% levy on energy and Justin Trudeau's threat of some retaliatory measures. "The economic consequences of a protracted trade conflict would be severe," Macklem said.
"In our January projection with no tariffs, we forecast growth of about 1.8% in both 2025 and 2026. But in the tariff scenario, the level of Canadian output falls almost 3% over two years. That implies tariffs would all but wipe out growth in the economy for those two years," he said. "Unlike the pandemic, if tariffs persist there will be no economic bounce-back."
Exports would fall 8.5% and investment by 12% in the first year of a trade war, while consumption would eventually fall 2%, he said. A weaker Canadian dollar would only partly offset the weakness while boosting prices for imports.
Even though Canada is the biggest buyer of U.S. exports and after excluding energy America runs a surplus, Macklem said that "increased trade friction with the United States is a new reality" and represents a "structural shift" for Canada.
Discussion of the trade threat pushed Macklem's original plan to discuss the regular five-year review of the inflation mandate into the background. The Governor said that given the durability of the 2% target over several decades, it won't be under review this time. Instead there will be more focus on whether monetary policy needs a different playbook in a world more prone to supply shocks than the past stance of seeking to look through temporary impacts.
The Bank will also study whether to change or expand preferred measures of trend inflation, another nod to the strains of the pandemic and rebound. Finally, in a nation with some of the world's most stretched housing markets, the Bank will look at the interaction between that and monetary policy. "We must consider how monetary policy affects housing demand and supply and how the imbalance between them feeds into inflation in shelter prices," Macklem said.