The Bank of Canada considered holding interest rates steady earlier this month but proceeded with a rate cut after weighing the risk of an economic downturn against the risk of rising prices, both caused by a trade war with the United States.
On March 12, the central bank’s governing council lowered the benchmark policy rate by a quarter-percentage-point to 2.75 per cent, the seventh-consecutive cut since last summer. The decision was a close one, according to a summary of the discussions published Wednesday.
“Some members suggested that it could still be appropriate to maintain the policy rate at 3 per cent until there is more clarity around tariffs and more information about their macroeconomic impact,” the summary says. “Other members suggested that the threat of tariffs and uncertainty had changed the outlook enough to warrant a further reduction in the policy rate.”
Ultimately, the six-person governing council, led by Governor Tiff Macklem, decided to cut once again to “provide some help to Canadians to manage the uncertainty related to tariffs.” However, this was accompanied with a hawkish message that the bank would “proceed carefully” with future rate decisions.
Financial markets put the odds of another rate cut at the next meeting in April at around 30 per cent, according to LSEG data. Traders are pricing in one to two more quarter-point cuts this year.
The Bank of Canada is navigating a complex set of economic cross-currents in a fog of uncertainty. The Canadian economy ended last year on stronger-than-expected footing, and there are signs that inflation is starting to pick back up after hovering around the bank’s 2-per-cent target since last summer.
If it wasn’t for U.S. President Donald Trump’s aggressive and erratic tariff threats, it would have made sense to pause the monetary policy easing cycle, the summary says.
The trade war, however, has muddied the picture. It’s too early to see the impact of Mr. Trump’s steel and aluminum tariffs and his other threats in the economic data. But they are already hitting Canadian consumer and business confidence. A central bank survey last month found that consumers are cutting spending, while companies are pulling back on investments and putting a freeze on hiring.
“The shift in sentiment was likely to translate into a slowing in domestic demand going forward. How much of a slowing was hard to say but they recognized it could be considerable,” the summary says.
The challenge for the central bank is that trade wars not only hurt the economy and kill jobs, but also increase prices. This happens because retaliatory tariffs and a weaker currency raise the price of imported goods, while companies pass along the cost of supply chain disruptions to consumers.
In short, a central bank – whose primary job is controlling inflation – can’t simply slash interest rates to support the economy, as it would in other crises, without risking a rise in inflation.
“Members discussed whether they were seeing early signs of inflationary pressures coming from higher input costs related to tariffs and uncertainty. They agreed it was too early to see these impacts in the CPI data. They noted that the extent and speed of the pass-through to consumer prices was uncertain and will require careful tracking,” the summary says.
Last week, Mr. Macklem gave a speech saying that the bank could not reliably forecast where the Canadian economy and inflation was headed, given Mr. Trump’s changeable policies. That means the bank has adopted a risk-management approach to monetary policy that tries to balance competing threats without relying on a central forecast.
“That means being less forward-looking than normal until the situation is clearer. And it may mean acting quickly when things crystallize. We need to be flexible and adaptable,” Mr. Macklem said.
Benjamin Reitzes, managing director of Canadian rates at Bank of Montreal, said the central bank doesn’t want to get ahead of itself, given the fluidity of U.S. trade policy and its uncertain impacts.
“Policymakers are extremely sensitive to upside inflation risks after the past few years, especially with fiscal stimulus likely playing a role in the response to the trade war,” Mr. Reitzes wrote in a note to clients about the summary. “That won’t keep the BoC from cutting rates if tariffs worsen, but it suggests any further easing won’t be aggressive and limits how low the Governing Council is willing to go.”