The Bank of Canada lowered its key interest rate as expected on Wednesday, a move two experts say is likely to be followed by fiscal stimulus from the federal government aimed at helping Canadians weather the ongoing trade war with the U.S.
Canada’s central bank lowered its overnight rate by 25 basis points (bps) from three per cent to 2.75 per cent, the seventh straight rate cut from the bank dating back to June of last year.
Warren Lovely, chief rates strategist at National Bank of Canada, told BNN Bloomberg in a panel discussion Wednesday morning that the rate cut came as “no surprise” given the threat posed to the Canadian economy by U.S. President Donald Trump’s many tariff threats.
“I think we all agree, monetary policy is not a perfectly calibrated tool for a trade war, we know there’s some inflation fears that come when we’re in a ‘beggar thy neighbour,’ full-on retaliatory trade fight so they’re, I’m sure, mindful of that,” he said.
“At the same time, we risk economic paralysis here, so it’s not appropriate to be at three per cent. The real question will be how far down interest rates need to go in conjunction with what we fully expect will be a government fiscal policy reaction as well… it’s going to be all hands on deck.”
Ed Devlin, founder of Devlin Capital, senior fellow at the C.D. Howe Institute and former head of Canadian portfolio management at PIMCO, said in the panel discussion that he expects a federal stimulus package to be more effective than the support issued to Canadians during COVID-19.
“I think Mark Carney has a better understanding of economics than Justin Trudeau does, so I think it’ll probably be better… but similar to COVID-19, there will be a coordination between the fiscal and the monetary agents,” he said.
“And how that works out, that’ll be key… these are unprecedented times, this trade war we’ve got with our closest friend and neighbour, so will (policymakers) think outside the box? I don’t know, but I hope so.”
At the same time the Bank of Canada released its policy decision on Wednesday, Canadian officials announced reciprocal dollar-for-dollar tariffs on U.S. goods in response to Trump’s 25 per cent levies on all steel and aluminum products that came into effect at the beginning of the day.
Tariff talk unavoidable
Lovely said that the Bank of Canada’s previous rate cuts had already helped to boost the Canadian economy in recent months, but trade tensions have since started to weigh on consumer and business confidence.
“You do need buyers to have confidence in the economic outlook and their own job prospects… the irony here is we had some signals that the Canadian economy was starting to show some signs of life in response to earlier interest rate cuts,” he said.
“So, on its own, if you could somehow suspend the tariff discussion and set aside geopolitics for just a brief moment, it’s not so clear that we need drastically lower interest rates at this juncture, but you can’t suspend it, we know that we face this threat.”
Lovely said that restoring business and consumer confidence in this uncertain economic environment should be the first priority for Canadian officials, who need to be forward-looking with the aim of building a more resilient and self-sufficient economy.
“The right decision for today was to lower interest rates, and I don’t think they’re done,” he said.
“I think the debate is how low do we need to go… to improve our economic prospects and maybe encourage the economic transformation that we all kind of agree we’re probably going to need, particularly if access to the U.S. market is not going to be as reliable as we’d like it to be.”
2% rates ‘the logical place to be’
Devlin said that he believes the Bank of Canada will continue to cut its key interest rate until it reaches two per cent, a sentiment shared by economists at two of Canada’s largest banks.
“To me, that’s the logical place to be,” he said.
“But I think the more important thing is that central banks in general, the Bank of Canada included, have this concept of what I call risk management… I would be very interested in hearing from the bank how they think of tariffs from a risk management perspective.”
Devlin argued that in all likelihood, the threat of tariffs will remain for all four years of Trump’s administration, and that the economic relationship between the U.S. and Canada has already been “permanently degraded.”
“They’ve reneged on their deal, so, logically, and (prime minister-designate) Mark Carney said this in his speech on Sunday, it’s time to diversify,” he said.
“So, what does the Bank of Canada think its role is in that plan?”
Lovely added that he “sympathises” with policymakers, both monetary and fiscal, considering the “extraordinary amount” of uncertainty that exists right now, but reiterated the need for long-term, strategic thinking.
“We’re going to need to take… extraordinary actions to set us up down the road. What you hope is that political leaders look through an electoral cycle or two and make those big, long-term structural changes that we’re going to need as Canadians,” he said.
“Because the old rules don’t apply… the old rules of engagement are gone.”
