Bank of Canada holds rates steady amid US trade policy uncertainty

Investing.com -- On Wednesday, the Bank of Canada (BoC) announced its decision to maintain the policy interest rate at 2.75%, aligning with consensus expectations. This decision comes after a series of seven consecutive rate cuts, the most recent being a 25 basis point reduction in March from 3.00% to the current rate.

BoC Governor Tiff Macklem stated that the Canadian economy concluded 2024 on strong footing, with inflation hovering near the 2% target since the previous summer. The aggressive rate cuts since spring had stimulated household spending and economic growth, giving the economy renewed vigor.

However, the recent shift towards protectionism in US trade policy and its erratic implementation have introduced heightened uncertainty, disrupted financial markets, and dampened global growth forecasts, with a consequent rise in inflation expectations. The unpredictable trajectory of US trade policy and the potential impact of a trade war on Canada are sources of considerable concern.

In response to escalating threats of higher US tariffs, the BoC had reduced the policy interest rate by 25 basis points in both January and March. Despite these measures, the future remains uncertain, with no clarity on the imposition, reduction, or duration of tariffs.

The BoC has chosen to maintain the current interest rate as it awaits more information on US tariffs and their implications. Governor Macklem emphasized that monetary policy cannot eliminate trade uncertainties or counteract the effects of a trade war. Instead, the central bank's role is to foster confidence in price stability among Canadians.

The Canadian economy is showing signs of a slowdown in business investment and household spending. After a robust 5.6% expansion in the fourth quarter of 2024, final domestic demand is projected to be nearly flat in the first quarter of 2025. GDP growth for the first quarter is estimated at around 1.8%, with a pull-forward in exports to preempt tariffs, but a decline in exports is expected to weaken growth in the second quarter.

The labor market, which was improving at the end of last year, is now feeling the strain of trade tensions. Employment figures were stagnant in February, declined in March, and hiring plans are being scaled back by businesses.

Inflation in Canada increased from 1.8% in January to 2.3% in March, driven by the end of the GST/HST holiday and a rebound in goods price inflation. The elimination of the consumer carbon tax on April 1 is predicted to reduce CPI inflation by approximately 0.7 percentage points for a year, while lower global oil prices will also exert downward pressure on inflation.

The BoC's Monetary Policy Report (MPR) presents two scenarios to illustrate the potential outcomes of US trade policy. In the first scenario, new tariffs are largely negotiated away, but growth stalls due to persistent caution. Inflation falls below the 2% target for the remainder of 2025 and into 2026. The second scenario posits a long-lasting global trade war with severe economic repercussions, including a contraction in Canada's GDP and a recession lasting a year, with inflation exceeding 3% in mid-2026 before softening again.

Governor Macklem concluded by acknowledging the significant shift in US trade policy since January and the resulting surge in uncertainty. New tariffs on key Canadian industries and other US trading partners have led to volatile financial markets. Canadian monetary policy will aim to maintain inflation control and support economic growth as the country navigates the challenges of an unwanted trade war.

In response to the announcement, CIBC (TSX:CM) Economics' Avery Shenfeld commented, "We see this as a pause, one tied to the Bank’s lack of clarity on the outlook ahead, rather than the end of the easing cycle, unless the tariff threat disappears in short order."

This article first appeared in Investing.com