Bank of Canada cuts interest rate to 3%

Article content

The Bank of Canada cut its interest rate by 25 basis points to three per cent on Wednesday, while warning that the economic consequences of a prolonged trade war with the United States could be severe, hindering growth while potentially reigniting inflation.

Article content

Bank of Canada governor Tiff Macklem noted that while inflation has held near the bank’s two per cent target since August and household spending is picking up, a trade conflict with the United States has clouded the economic and inflation outlooks.

Article content

“A long-lasting and broad-based conflict would badly hurt economic activity in Canada,” Macklem said. “At the same time, the higher cost of imported goods will put direct upward pressure on inflation.”

Watch the Bank of Canada press conference here

The central bank runs through a number of tariff scenarios in its monetary policy report. In its “benchmark calibration,” which assumes price changes in line with patterns observed with previous tariffs, a 25-per-cent tariff and subsequent equal retaliation from Canada, would lead to a hit of 2.5 percentage points to Canada’s gross domestic product (GDP) at the end of the first year.

A second scenario assumes there is a larger decline in U.S. demand for Canadian goods, which would lead to a hit of three percentage points to Canadian economic growth. All scenarios would mean an increase in CPI inflation in Canada and the U.S. over a three-year period.

“Unfortunately, tariffs mean economies simply work less efficiently — we produce and earn less than without tariffs,” said Macklem. “Monetary policy cannot offset this. What we can do is help the economy adjust.”

Article content

Macklem added the central bank only has one policy instrument, its interest rate, which can’t address both weaker output and higher inflation at the same time.

Absent tariffs, the central bank revised down its previous GDP projection from 2.1 per cent growth in 2025 to 1.8 per cent, due mainly to reduced immigration targets introduced by the federal government in the fall, but also a decrease in investment sentiment in Canada because of the threat of tariffs.

“In Canada, there are already signs that the threat of tariffs is weighing on consumer and business confidence and investment intentions,” the Bank’s Monetary Policy Report said. “This threat has also contributed to the recent depreciation of the Canadian dollar.”

The bank expects inflation to remain around the two per cent target over the next two years, with temporary effects caused by suspension of the HST/GST wearing off in March when the tax holiday comes to an end.

The bank also addressed concerns over the depreciation of the Canadian dollar. While it acknowledged the widening differential between interest rates in Canada and the U.S. has had some impact, it said the main cause of the depreciation has been driven by the foreign exchange premium due to the uncertainty brought on by the threat of U.S. tariffs.

The central bank also announced the end of quantitative tightening and adjusted the deposit rate to a spread of five basis points below the bank’s policy rate.

• Email: jgowling@postmedia.com

Bookmark our website and support our journalism: Don’t miss the business news you need to know — add financialpost.com to your bookmarks and sign up for our newsletters here.

Share this article in your social network