With US tariffs now in effect, analysts increasingly predict that the Bank of Canada may need to implement aggressive interest rate cuts to mitigate the economic fallout and stabilize the economy.
Defying expectations of an extended reprieve, US President Donald Trump moved forward with heavy trade levies on Canada. Economists say this new economic reality could unravel much of the progress Canadian policymakers have made.
What Will Tariffs Mean for Bank of Canada Interest Rate Cuts?
As the full scope of US levies and their expected devastating impact on the Canadian economy become clearer, analysts are recalibrating their expectations for the Bank of Canada’s next move. A growing number of economists now see a supersized interest rate cut as a real possibility as the central bank scrambles to contain the immediate and long-term damage the tariffs will likely inflict on their largest trading partner. Before this trade war, many economists had expected the Bank of Canada to pause its rate cuts.
The Bank of Canada has cut overnight interest rates six times since last June, including two jumbo half-point cuts at the end of 2024. Altogether, the bank has lowered its policy rate to 3% from its peak of 5%.
Since the tariffs have taken effect, there’s been a selloff in Canadian stocks and a drop in the value of the Canadian dollar, suggesting a bleaker economic outlook. The following is commentary from economists on the impact of tariffs and the outlook for interest rate cuts from the Bank of Canada.
Stephen Brown, deputy chief North America economist, Capital Economics
“If the US tariffs remain in place, Canada will undoubtedly fall into recession. The limited decline in the loonie so far suggests markets are still pricing in a quick U-turn from the Trump administration. But even if the tariffs are soon lifted, their imposition represents a sea change for the US-Canada trade relationship and, against the backdrop of plunging immigration and poor productivity growth, the best-case scenario now is a sustained period of even weaker GDP growth than we previously expected.
“For now, the market reaction has been somewhat limited, with the Canadian dollar at USD 0.69 and so still stronger than the low of less than USD 0.68 recorded in late February. That limited reaction suggests that investors are banking on a U-turn from Trump, but it also means that these tariffs will hit Canada’s competitiveness by even more than we assumed. “The positive is that the stable exchange rate reduces the upside risks to inflation and provides more scope for the Bank of Canada to respond with looser monetary policy. The Bank is likely to cut interest rates by at least 25 basis points next week, and a larger 50-basis-point move is certainly not out of the question.”
Frances Donald, chief economist at RBC
“The ultimate impact of these tariffs on Canada and the US will depend on how long they—and retaliatory measures—remain in place. Those are political decisions and difficult to economically forecast. The movement of currencies is key as well, because it can buffer some of the impact on inflation and growth on both sides of the border.
“As a specific timeline, we previously delineated a duration of three to six months to show material mark downs in growth for the Canadian and US economies. Tariffs would likely reduce real gross domestic product to zero in 2025 if implemented beyond a year and lead to a 2% contraction in 2026 with a peak unemployment rate more than 8%.
“The Bank of Canada has been noncommittal in how it would respond to a tariff shock—waiting to see whether inflation or growth dominate. Without tariffs, we expected the Bank of Canada to gradually cut rates to 2.25%. Now, we expect that the longer tariffs remain in play, the greater the likelihood that rates fall faster and by a larger magnitude.”
Royce Mendes, managing director and head of macro strategy at Desjardins Capital Markets
“The facts of this tit-for-tat trade war have now come into clearer focus, but the fallout is anything but. Although market participants clearly see the escalation in tensions as negative for risky assets, the price action has thus far been contained, with global investors and businesses having had a month to plan for this event. Hopes that the trade conflict will be short-lived are also limiting market reaction, but that may prove to be too optimistic.
“In the near-term, the Bank of Canada is very likely to cut rates another 25 basis points next week, leaving the policy rate at 2.75%, the midpoint of the central bank’s estimated neutral rate range. Whether or not tariffs are lifted before the subsequent decision, Canadian central bankers are likely to reduce rates again in April to move policy at least modestly into stimulative territory. In addition to the duration and intensity of the trade war, the ultimate extent of the easing cycle will be determined by the response in economic activity and inflation.
“Uncertainty is already weighing on the economy in Canada. That said, while an increase in consumer prices is expected, undue moves in inflation expectations could limit the Bank of Canada’s room to maneuver. Monetary policy is not well suited to address a supply shock like this, so central bankers will want fiscal policymakers to do more of the heavy lifting. The federal government is constrained at the moment because Parliament is prorogued, so the provincial responses might be more timely.”
Tu Nguyen, economist at RSM Canada
“Canada’s economic landscape is set to change dramatically as US tariffs take effect. A recession is anticipated this year if the tariffs and retaliatory measures remain in place. Businesses, especially exporters, could need to cut jobs at a time when prices increase, unemployment rises and consumers pull back. While Canada’s manufacturing, energy and food sectors will be hit immediately, no sector will be spared. In contrast to the COVID-19 pandemic, when recovery quickly followed, tariffs deliver a structural shock to the Canadian economy that could be felt for years to come.
“While the economy will eventually grow as supply chains adapt to a new global reality, one lingering consequence could be a downward shift of the growth path for this year and next. The Bank of Canada will likely cut its interest rate in the next meeting to soften the blow of tariffs on the economy.
“Volatility will remain high in the foreign exchange market, with the Canadian dollar staying low in the next few months. During times of global economic uncertainty and crises, the US dollar often gains value as a safe-haven currency in relation to other currencies.”
Douglas Porter, chief economist at BMO Capital Markets
“Trump’s tariff hammer will come down hard on Canada’s economy. If the announced tariffs remain in place for one year, the economy would face the risk of a moderate recession. A couple quarters of contraction are well within the realm of possibility. With little confidence given the lack of historical precedent, we estimate that the tariffs will reduce real GDP growth by roughly 1.5 percentage points to around 0.5% in 2025. This reflects reduced demand for Canadian exports to the US (which account for about a fifth of GDP), disrupted supply chains impeding business activity and consumption, and heightened uncertainty that reduces business investment.
“It also reflects a reduction in domestic demand due to higher prices stemming from retaliatory tariffs and a weaker Canadian dollar. From a sectoral lens, a wide range of Canadian industries derive at least half of their revenue from US exports. Near the top of the list is motor vehicles, but others with high exposure include auto parts, clothing, wood products, chemicals, iron and steel, aluminum, machinery, computers, and electrical equipment. While the oil industry has very high exposure, we assume the 10% tariff will have little dampening effect given a combination of a weaker loonie, Canadian producer price cuts, and US refinery cost absorption.
“The Bank of Canada’s rate cut in late January was partly portrayed as a risk management move compelled by the rising risk of US tariffs. With that risk now being realized, we reckon the Bank will lean against the expected significant economic slowdown and steeply escalating risk of recession along with associated disinflationary pressures. However, there will be a measure of caution in the policy easing, with inflationary pressures simultaneously prodded by retaliatory tariffs and Canadian dollar depreciation. Previously, we projected the Bank would cut the policy rate two more times this cycle, by 25 basis points in April and July (ending at 2.50%). We now look for the quarter-point pace to continue in each of the next four meetings until July, taking the rate to 2.0%. The net risk is that we eventually go even lower, if the Bank is comfortable with the prevailing inflation backdrop later this year.”
Derek Holt, economist at Scotiabank Economics
“The US has declared economic war on Canada, Mexico and China. Friends, allies and economic partners no more, the gloves are off with this administration that demands respect but gives none whatsoever. It is clear that Trump prefers tariffs and that everything about border controls is absolute rubbish; this means negotiation won’t work, hitting back twice as hard might be the only option. Clearly this is a pugilistic bunch of bullies in the US administration with the tone set by Trump’s litigious, divisive and extraordinarily dishonest ways.
“The Bank of Canada is likely to cut next week as tariffs tip the balance in that direction, but expect a very measured bias given the potential effect of tariffs on supply chains and inflation. [Data drawn from Governor Tiff Macklem’s recent speech] clearly show the hits [from tariffs and countermeasures] to GDP, exports, business investment and consumption, but also the sustained lift to inflation.”
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
