Double Impact: Bank of Canada Cuts Rates as Ottawa Retaliates Against Steel and Aluminum Tariffs

“With tariffs on steel and aluminum coming into effect this morning, the Canadian economy faces another large hit to the head. The stronger growth mentioned by the Bank of Canada will become irrelevant in the months to come if tariffs continue to escalate. The added uncertainty is clearly showing up in the Bank’s survey data, which reinforces the need to be in a lower policy stance to preserve diminishing Canadian sentiment.”

• Today the Bank of Canada lowered its policy rate by 25 basis points (bps) to 2.75%. This move was anticipated by financial markets as U.S. tariff threats materialized in conjunction with a softer February employment report. Pricing before the announcement implied a strong likelihood (90%) of a 25 bps cut and expectations for an April cut are currently a coin toss.
• The U.S. tariffs on steel and aluminum took effect and subsequent retaliation from the Canadian federal government was announced today. These retaliatory tariffs include steel and aluminum and would bring the overall response to $60 billion.
• The inflation risks on balance are low given the Canadian economy will continue to underperform and keep inflation within the target range (1-3%). We see inflation moving a bit higher temporarily, following lower readings from the HST holiday. Estimates of the federal government’s initial retaliation of $30 billion on inflation are around 0.6%, assuming full-passthrough. The Bank summarized today’s decision as follows: “Canadians are more worried about their job security and financial health as a result of the trade tensions, and they intend to spend more cautiously. Job security concerns increased particularly among workers in export-oriented industries, including manufacturing, mining, and oil and gas.”
• At the same time, Canada’s economy surpassed expectations in Q4 2024, but continues to operate below its potential. Real GDP grew 2.6% in the fourth quarter, well-above the Bank’s forecast (1.8%). Upward momentum in GDP and an improvement in consumption per capita is encouraging, but will be reversed with tariffs in place. Domestic challenges like lower immigration targets and the freeze on business investment is added risk to growth this year. And new tariffs will hurt our exports and weaken business investment.
• The Bank released preliminary results from their surveys in the first quarter. Consumers are signaling intentions to delay major purchases. Businesses are signaling lower hiring and investment intentions, which will slow domestic demand.
• Inflation expectations for the year-ahead increased for both businesses and consumers. After much progress, Canadians now expect inflation to average 4%, compared to 3% in October 2024. Pass-though intentions of tariffs are mixed, with half of businesses indicating no price increases, but 27% expect to pass on nearly all of the tariffs on products to Canadians.
• As such, our base case expects interest rates in Canada will ultimately need to fall below the Bank’s “neutral level” (2%) in 2025. A more accelerated timeline could take place if broad-based tariffs are imposed in the coming months. Tariffs will weaken productivity and make supply-chains more inefficient. The Governor mentioned “We ended 2024 on a solid economic footing. But we’re now facing a new crisis. Depending on the extent and duration of new US tariffs, the economic impact could be severe. The uncertainty alone is already causing harm.” This implies a lower rate stance, despite price pressures mounting.
• Market expectations for the Federal Reserve remain highly likely (95% chance) that the U.S. Federal Reserve will hold rates on March 19. Therefore, we expect the gap between Canadian and American rates to grow in 2025, causing the Canadian dollar to depreciate against the U.S. dollar. A weaker CAD adds to inflation pressure by making imports more expensive, the exchange rate is a key shock absorber that could help partially cushion the hit to Canadian exports if Trump follows through on his tariff threats.