Canada’s facing a trade war with its largest partner, and it may send interest rates plunging. BMO Capital Markets wrote to investors after the first round of tariffs were announced this weekend. The bank now expects rates to be slashed much more aggressively, trimming another point off the bottom for overnight rates. The plunge would test the historic extremes for rapid easing set nearly 30 years ago.
The Canada-US Trade War Is Set To Begin Next Week
Canada and the US kicked off its trade war this weekend. The US administration unveiled a 25% broad tariff on all goods from Canada, with a 10% tariff on energy being the only exception. It’s set to go into effect on Tuesday, with the country emphasizing it will adopt additional measures if Canada responds.
Canada’s response was smaller and more targeted. The country will hit them with a 25% tariff on $155 billion in US imports, with $30 billion in categories going into effect on the same date. The rest are set to go into effect 21 days later. Non-tariff measures such as removing US products from Crown-owned stores are expected to have an additional impact.
The hit to Canada’s GDP has been discussed frequently over the past few weeks, but BMO outlined more specific expectations for inflation and unemployment. The bank sees CPI adding a little under a point this year, and the unemployment rate rising to 8%, adding a point to its previous forecast sans tariffs.
That’s going to require a lot of stimulus.
Canadian Interest Rates May Plunge Further Than Thought
Last week, the central bank slashed rates despite noting inflation risks and low CPI being temporary. A shift that means the central bank is no longer addressing its concrete issues, but in full panic mode. “Note that the Bank of Canada’s cut last week was partially viewed as a risk management move to guard against, well, this situation,” explained Shelly Kaushik, an economist at BMO.
BMO now sees the central bank slashing rates much more aggressively on this path. “Previously, we expected the Bank to cut two more times this year, leaving the terminal rate at 2.50%. Now, we’re forecasting 25 bp cuts at each meeting until October, pulling terminal 100 bps lower to 1.50%,” she forecasts.
Adding, “This means Canada-U.S. overnight rate spreads will push past -225 bps, testing the all-time extreme from 1997.”
The terminal interest rate is when central banks are projected to end their monetary cycle. In this case, it’s the amount of ease believed to bring the inflation rate to target.
Canada’s Circular Inflation Model Means Atypical Response
Canada’s unique CPI methodology plays a role here. Since the cost of borrowing is heavily influenced by the rate of inflation, components heavily influenced by borrowing aren’t included. Borrowing costs aren’t the cost of goods or services, but the annualized cost of capital to purchase those items. Since cheap credit is designed to raise demand and therefore cost, it’s already priced in. Including financing rates places extra downward pressure on CPI. However, it would only register as deflation to those who think breaking up a $100 payment into 4x easy $30 monthly installments, means falling prices.
Canada is one of the only countries to use this infomercial-style inflation model. As a result, its model is less about actual prices than other countries and circularly reports. By cutting rates, inflation falls immediately—the price of nothing else has to fall and demand doesn’t have to increase. It’s more of a circle jerk than anything, so Canada is so much more “effective” at CPI control. It isn’t measuring the same thing. Not by a long shot. But that’s how it works! And that is also why Canadian policymakers are less likely to respond like other countries engaged in traditional monetary policy.
Both Canadian and US leaders are scheduled to meet later today. It’s unclear if they can promptly agree and mitigate the most drastic shock. If they do, the outlook will likely shift again—though it will almost certainly have eroded from the pre-tariffs discussion.
I can’t tell if and where you are being sarcastic because I don’t understand your explanation of what is going on.
While i appreciate thaf the.economy is going to drop due totariffs, you cant just drop interest rates every time we have a gdp problem.
The usd is supported by the fact it is still themain global reserve currency. If cabadas interest rates are 100-150bp lower than us treasuries, the demand for canadian bonds.will also drop, since the ability to pay interest is also affected. This.will further hurt the dollar, adding more inflation, in addition to anh tariffs imposed.
This is how we end up in 1982 again high inflation, high rates, no economic growth.
We jeed to focus on investing in ,things that generate gdp like resource extraction.
After wasting 10 years chasing *green* economies, we are out 500B, and having lost 65% of our standard of living in the process.
We cant afford to try to revive housing as at a gdp per caputa of 53kusd an average house prive of 9-12 times that is unsustainable
Execellent piece. The.information on how.wrong our cpi is all the time, how it shelters our banks, just az the tier one. Capital does as well meaning ourbanks have.less credit.risk reserves.
Therefore, arguments that our cpi is lower than the usa.or eu is nonsense. Similarily claiming that our banks are ‘safer’ than us banks is equally disengenuous. Canadas.banks are far.more.profitable,.mainly because of sky high fees, but in terms of protection, and safety, thry are only ‘safe’ because our govt backs them 100% of yhe time with our taxes.
What we have seen in canada since 2015 has been a shift in capital from productive investmenrs like energy, manufacturing, mining, into residential real estate.
This is bad for many reasons, first and formost, residential or commercial real estate is rarely priductive beyond increasing leverage and inflation. It does not generate exports, forex or gdp thatnis sustainable. Consider, in toronto a small house that cost 400K in 2008, is now selling for 1.7m. The owner did little to ‘improve’ the.property, but because of easy money mo etary policies, the valuation was 4 times higher.
This is obvious because our m3 has risen by 269% since 2015. That means for every dollar in circulation in december 2015 there are almost 3 dollars now. This is not growing the gdp. This is why our dollar is in the 68c range from par with the usd in 2015.
Secondly, our gdp per capita in usd is basically flat to where it was in 2015. The problemis that the usa has seen almost 50% coumpound inflation since then. So while american gdp per capita is now close to 90k, we are stl at 53k. In effect this means we are all 67% poorer than if we lived in thw usa since 2015.
Finally, since so much of our investment has veen redirected to housing, it has drastically reduced the capex in things that actually would help increase our standard if living have been lost. This is a disaster that will hurt us for decades. Ws neex to make sure that we can improve the mess ws are in.
In effect, the real loss of standard if.living since 2015 is only comparable to the.great depression in terms of scale. So lower rates are only prolonging the pain, we besd a market correction in housing to reset this mess. The.problem is.no one is saying any of this.
Insanity. Lower cdn rates is an ‘American first priority’.
Lower rates will tank the cdn economy, savage savers, savage consumers with higher prices, prove social contract is broken, create mistrust in cdn yo-yo central bank, that puts usa interest first.
Where as, if the tariffs are fully applied that would create huge inflation in usa – worth saying, Americans pay it- and that is not going to help Republicans get elected again. And where is the usa going to replace 60% of their oil from, and wheat, lumber, nickel, steel, gas, electricity. Sure, Russia will help them, not. They have no sustainable alternatives to Canada.
Implemented like this, cdn will boycott usa companies, and I hope they do.
If Trump, America, can’t afford their import nesssities. That is their problem. Then they should make stuff we want to buy, instead of reselling crap from China.
Allowing Trump to manage his key trade partners like this, is bad practice. Sets precedent for more and more over the top responses.
Trump and America agreed to the current trade arrangements. No one forced them to buy from us. This was their arrangement. So unilateral tariffs is a breach of contract to supply. Game on. If that’s how they want to play it. I don’t need Netflix. But they need oil, electricity, etc. Bring it on. If that us Trump’s idea of how to conduct trade.
Better response is a cdn export service fee of 25% on top of Trump’s 25% tariffs. Need to improve accounting rules for foreign operations in Canada anyways. See if that brings them to negotiations.
Let’s sell to usa, but this over action by BOC is insanely lame, and damaging, to real Canadians.