Bank of Canada Weighs Big Cut as Tariff Looms: Decision Guide

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(Bloomberg) — The Bank of Canada is likely to cut interest rates by half a percentage point for a second consecutive meeting, bringing borrowing costs to more neutral levels and better positioning the economy for the potential crosswinds of a tariff war.

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Markets and most economists expect policymakers led by Governor Tiff Macklem will cut the benchmark overnight rate by 50 basis points on Wednesday. That would bring the policy rate to 3.25%, the top end of the range of the central bank’s estimate for the neutral rate — a theoretical level where borrowing costs neither stimulate nor restrict the economy.

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With inflation nearing the 2% target, the central bank said it is now looking at economic growth to move forward to achieve it more easily. In October, the Bank of Canada cut borrowing costs by half a point. A second move of that magnitude is likely to give the economy a stronger recovery.

“We’re still in that oversupplied area of ​​the economy and it doesn’t look like the exit gap is closing the way the bank wants it to,” said Veronica Clark, an economist at Citigroup, in an interview. which means that the economy is underperforming compared to its potential. “The Canadian economy no longer needs restrictive tariffs.”

After overseeing one of the most difficult periods of inflation in the history of the central bank, Macklem is now dealing with normal rates while weighing the response to a potential trade dispute. The severity and length of that battle will not be known until Donald Trump is inaugurated and his policies are fully defined.

Macklem’s job is to keep the focus on monetary policy consistent with a lack of near-term data, while saying the central bank won’t react to trade threats or factor them into its models until more clarity is provided.

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“There is a reasonable case to be made that deep trade uncertainty with the US is itself the reason for the easy situation, to help protect the economy from external pressures,” wrote Doug Porter, an economist at the Bank of Montreal, in a statement. report to investors.

Last month, Trump said he would apply 25% tariffs on all Canadian goods imported into the US, a move that would devastate the Canadian economy, a threat he repeated this week. On Monday, Prime Minister Justin Trudeau said he would respond in kind, though he did not specify the scope or targets of any retaliatory tariffs.

The residual impact of the tax war will be more than annual inflation in Canada, according to 14 of 15 economists polled on the topic in a Bloomberg survey conducted from Dec. 3 to Dec. 6. That would leave Macklem in a tough spot. as a playbook for stagflation – a period of sluggish or shrinking economy with rising price pressures – is unclear.

Regarding the central bank’s response to a trade war, five of the 14 economists who answered the question said it should bring interest rates to encouraging levels. Three said policymakers should keep borrowing costs moderate, while two said a pause was the best course of action. One said moving to restrictive measures was the best option, while three others offered other suggestions.

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However, the threat of tariffs is likely to affect the economy. Consumer confidence was rising steadily before Trump’s election, but has reversed course – expectations are at their lowest level of the year. Ten of the 15 economists surveyed said Trump’s threat would have “some impact” on business investment, while another five expected a “major impact.”

Canada’s economy is not slowing down, but growth is weak. Despite strong household spending driven largely by population growth, the economy grew by just 1% in the third quarter, below bank estimates, as investment and assets grew. Although housing starts have started to slow and there are no signs of widespread job losses, there is significant slack in the labor market – the unemployment rate rose 0.3 percentage points to 6.8% in November, the highest level since the Covid-19 era.

The Bank of Canada’s rate path is now expected to differ from that of the Federal Reserve, and next year’s spread between expected policy rates is now 119 basis points. That helped push the loonie to trade at its lowest level against the greenback since 2020.

Analysts are divided on whether Macklem has begun to push policy too far from its neighbor to the south. In the survey, eight out of 15 economists said the bank and the Fed would be best separated by 150 basis points or less — and seven said the margin was greater than that amount. If the Bank of Canada cuts by 50 basis points on Wednesday, its policy rate will be 150 basis points below the upper limit of the Fed Funds rate.

Economists now see the central bank’s rate of cuts reaching 2.25% this cycle, 75 basis points lower than the August survey.

—Courtesy of Dana Morgan and Jay Zhao-Murray.

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