The Bank of Canada cuts interest rates by 25 basis points as expected to respond "cautiously" to tariff impacts

According to Zhitong Finance APP, the Bank of Canada announced on Wednesday that it would lower the benchmark interest rate by 25 basis points to 2.75%, the lowest level since September 2022. Meanwhile, Bank Governor Tiff Macklem warned that the trade dispute between the U.S. and Canada has evolved into a "new crisis" and stated that a new round of tariffs could have a severe impact on the economy. However, central bank officials emphasized that they have not entered a fixed rate-cutting trajectory, and future policy adjustments will depend on inflation and economic growth conditions.

Macklem noted in a statement, "We are facing a new crisis. Depending on the scope and duration of the new U.S. tariffs, the economic impact could be quite severe." He also stated that the uncertainty surrounding the current tariff dispute is "ubiquitous" and has negatively affected economic activity.

Central bank officials pointed out that the constantly changing U.S. tariff policy has affected consumer spending willingness and restricted companies' hiring and investment plans. Due to the ongoing uncertainty, the Bank of Canada stated that it will remain cautious in future interest rate adjustments and weigh the upward pressure of inflation against the downward risks brought by weak demand.

After the interest rate cut announcement, the Canadian dollar's gains narrowed, rising 0.1% against the U.S. dollar to 1.4420 Canadian dollars per 1 U.S. dollar. At the same time, Canadian government bonds were sold off, with the 2-year government bond yield rising to 2.525%.

Central bank officials reiterated that their policy intervention capabilities are limited. The trade war has not only brought cost pressures but could also trigger inflation shocks. The central bank stated that it will closely monitor how cost pressures are transmitted to consumer prices and emphasized, "Monetary policy cannot offset the impact of the trade war, but it can ensure that price increases do not lead to long-term inflation."

This interest rate cut confirms the central bank's policy shift to provide some support for the Canadian economy amid the economic uncertainty brought by the trade dispute. However, officials clearly stated that the magnitude of this rate cut is far less than during the COVID-19 pandemic when the policy rate was lowered to 0.25%.

The central bank also emphasized that it will closely monitor changes in inflation expectations. The latest survey shows that consumers generally expect tariffs to push up prices, leading to an increase in inflation expectations. The central bank stated in its announcement, "Maintaining stable medium- to long-term inflation expectations is crucial to ensure that any price increases are temporary."

Despite the new challenges posed by the trade dispute, central bank officials remain optimistic about the growth prospects of the Canadian economy. They noted that compared to expectations at the end of last year, the growth path of the Canadian economy is "significantly strong," with fourth-quarter economic growth exceeding expectations and data being revised upward. Officials stated that the interest rate cut is boosting consumption and the housing market.

However, they also warned that the trade war could impact Canada's job market. Recently, as labor demand has increased, the Canadian job market has shown signs of recovery, but the central bank pointed out, "There are signs that escalating trade tensions could undermine the recovery of the job market." Market analysts believe that the Bank of Canada is facing a dilemma. Rishi Mishra, an analyst at Futures First Canada Inc., stated, "The central bank hopes that the issue of economic growth will be addressed by government stimulus policies, while the central bank focuses on controlling inflation. However, there is currently no clear solution to the situation."

Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce, pointed out in a report, "This rate cut may only be a stopgap measure, but we are still unclear about how much damage U.S. trade policies will inflict on the economy." The bank expects that due to the slowdown in economic growth, the Bank of Canada may cut rates two more times before June, each by 25 basis points.

Stephen Brown, North America Deputy Chief Economist at Capital Economics, stated that the Bank of Canada remains cautious about further easing policies. "The impact of declining demand on prices has a certain lag, while the price increases due to tariffs are immediate. This means the central bank may act more slowly than we previously expected in implementing further rate cuts."

Last week, U.S. President Trump announced a 25% tariff on most Canadian and Mexican goods but later indicated that the implementation could be delayed by a month for products that comply with the North American Trade Agreement.

In response, Canada implemented retaliatory tariffs on U.S. goods worth CAD 30 billion (approximately USD 20.8 billion) on March 4 and announced an additional CAD 30 billion in tariffs on Wednesday to counter U.S. tariffs on steel and aluminum. Additionally, the Canadian government plans to implement broader retaliatory tariffs on April 2 unless both sides can reach a settlement.

McLellan pointed out that the recent depreciation of the Canadian dollar and Canada's countermeasures are increasing the economic costs of the trade war. He stated, "The depreciation of the Canadian dollar and the new retaliatory tariffs will make imported goods more expensive. At the same time, businesses have reported to us that the uncertainty itself brings additional costs."