Tough Spot: Bank of Canada Likely to Cut Rates Amid Trade Uncertainty

TORONTO—The Bank of Canada's interest rate announcement on Wednesday comes amid uncertainty due to a shifting trade battle with the United States.
Most economists expect the central bank to drop interest rates by another quarter point while it waits to see how long the spat with Canada's leading trade partner will endure.
The Bank of Canada faces a difficult task: establishing monetary policy when inflation is tenacious, and the economy is picking up steam. However, chances of a sudden slowdown due to US tariffs loom on the horizon.
"It's a very difficult position for the Bank of Canada to be in," said Randall Bartlett, Desjardins Group deputy chief economist.
Even though US President Donald Trump carried through on his pledge to put sweeping tariffs on Canadian goods on March 4, the specific nature of those levies has altered with a series of pauses and adjustments in the days that have followed.
"Who knows how this will play out daily? "It's almost anyone's guess," Bartlett explained.
The Canadian economy will suffer significantly if a trade war with the United States continues.
According to Bartlett, trade disruptions are expected to raise inflation in the near term, and job losses in hard-hit industries could swiftly build up if tariffs are not lifted.
Desjardins anticipates Canada to enter a recession by mid-year if hefty tariffs remain in place.
That's a far cry from the Canadian economy's trend leading to 2025.
Late last year, there were hints that the Bank of Canada's prior interest rate decreases were beginning to affect the economy. A reinvigorated Canadian consumer led to a boom in retail activity to the end of 2024, implying that, absent a significant disturbance, 2025 would be a year of recovery.
Following six consecutive cuts to bring the Bank of Canada's interest rate down to 3%, Bartlett said the "economic tea leaves" should have told the central bank to pause its easing cycle and wait to see where inflation and the economy settled in the coming months.
"But then obviously we got hit with the tariff shock on March 4 and all bets are off in terms of what that means ... for the Bank of Canada," says Bartlett.
According to LSEG Data & Analytics, financial markets were mainly positioned for a quarter-point rate drop as of Friday. Before tariffs were implemented, markets indicated that the probability of a hold or cut was nearly equal.
In a speech on February 21, Bank of Canada governor Tiff Macklem stated that if tariffs are broad-based and long-lasting, "there won't be a bounce back" in the Canadian economy as during the recovery from the COVID-19 pandemic. It would be a "structural change," he cautioned.
Macklem went on to clarify that the central bank cannot simultaneously lean against poor growth and increasing inflation caused by a tariff shock. He stated that the central bank intends to utilize its policy rate to "smooth" the economic impact while maintaining inflation expectations firmly anchored to the two percent target.
In a note to clients on Friday, Andrew Grantham, senior economist at CIBC Capital Markets, stated that while the central bank "can't solve the tariff issue" with rate cuts, it can help the economy move through the turmoil.
CIBC anticipates the bank will announce a quarter-point decrease on Wednesday, lowering the benchmark rate to 2.75 percent. If trade uncertainty lasts, further cuts will follow this year.
Bartlett predicted that the Bank of Canada would consider a 25-basis-point drop to help the Canadian economy but refrain from doing anything more significant while it waits to see how long tariffs remain in place in the coming weeks.
He warned that the central bank's ability to lower its policy rate will be limited, owing in part to the weakness of the Canadian dollar.
According to Bartlett, the loonie is vulnerable to trade war-related losses and a widening gap between Canadian and US policy rates.
Suppose the Bank of Canada cuts its policy rate too sharply. In that case, the loonie may also fall, resulting in a more significant increase in inflation on food and other items imported from the United States.