Bank of Canada warns economic consequences if the U.S. trade war escalates

Macklem outlined the distinct economic consequences of a prolonged trade conflict in his speech at the Mississauga Trade Commission on Friday, especially if Canada itself retaliates with its own tariffs.

“The increased trade friction with the United States is a new reality,” he said. He warned that the shock is not temporary – fundamentally, it will change Canada’s economic trajectory.

“The economic consequences of protracted trade conflicts will be serious,” he continued. “If tariffs are persistent and based on broad, there will be no rebound. We may eventually return to current growth rates, but output levels will Permanently lowered.”

Economy weakened and inflation higher

Macklem details the significant increase in tariffs will lead to immediate decline in exports, which will lead to layoffs and unemployment.

According to the current banking model, “Exports fell by 8.5% in the year after the tariffs came into effect.

While lower export income will curb household income and slow consumer spending, retaliatory tariffs will also drive the prices of many imported goods.

“About 13% of the Canadian CPI basket is made up of goods imported from the United States,” McClum said, stressing that the weaker Canadian dollar will only exacerbate the problem by making all imported goods more expensive.

What does this mean for interest rates

As inflation shrinks, Canadian banks have been steadily lowering interest rates, with policy rates now well below their recent highs. But McClum warned that central banks would have limited ability to protect their economy from trade shocks. While lower interest rates can help support domestic demand, the BOC will have to stomp carefully to avoid inflation.

“Monetary policy can help adjust and adjust by supporting demand, so it won’t weaken much more than supply. But how much support can be provided by monetary policy is limited by demand that controls inflation,” he said.

“Monetary policy can help adjust the adjustment, but cannot restore lost supply or offset economic losses completely,” he said. “The initial impact of tariffs is a one-time increase in consumer price levels. Monetary policy cannot change that.”

This presents challenges for mortgage borrowers. A weaker economy may support further tax cuts, but if inflation remains sticky due to rising import prices, the BOC may be forced to hold higher-than-expected interest rates. “In short, monetary policy needs to ensure that inflation increases are temporary,” McClum said.

The long-term transformation of Canada’s economic landscape

In addition to monetary policy, McLean stressed that Canada needs structural changes to offset the negative impact of the trade war.

This includes reducing inter-provincial trade barriers, improving labor mobility, and investing in better East-West transportation links to expand access to overseas markets.

But while these policy shifts may help in the long run, the direct outlook remains challenging.

“The protracted trade conflict will greatly reduce exports and investment. In the long run, this will cause losses in jobs and increase inflation and lower our living standards,” Macklem said. “One uncertainty alone has caused harm.”

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Last modified: February 21, 2025