The Bank of Canada cuts overnight interest rate to 2.75%

Stephen Meurice: Amid on-again-off again tariffs and looming threats of more, the Bank of Canada has announced another interest rate cut.

Tiff Macklem [at press conference]: Today, we lowered the policy interest rate by 25 basis points, to two and three quarters percent. 

SM: That’s Bank of Canada Governor Tiff Macklem at his latest news conference. 

Tiff Macklem [at press conference]: The Canadian economy ended 2024 in good shape. Inflation has been close to the 2% target since last summer. Substantial cuts to our policy interest rate through the second half of last year boosted household spending and strengthened economic growth. However, in recent months, the pervasive uncertainty created by continuously changing US tariff threats has shaken business and consumer confidence. This is restraining household spending intentions and businesses’ plans to hire and invest. 

SM: Here as always to help unpack the decision is Scotiabank’s Chief Economist, Jean-François Perrault. He’ll give Armina Ligaya his take on the announcement and what it means, what it might signal about the Bank of Canada's larger economic outlook, how tariff threats may affect interest rates moving forward and much more.

I’m Stephen Meurice and this is Perspectives. Now, here’s Armina Ligaya 

AL: JF, welcome back to the show.

JFP: Thanks, Amina. It’s a pleasure to be on again.

AL: Now, before we begin, I just want to mention that we're recording this early in the afternoon on Wednesday, March 12th. As you know, things have been changing so rapidly and may very well be different by the time we put out this episode, so let's start with the central bank's latest move. JF, what's your main takeaway?

JFP: Well, they did as expected. They cut interest rates by 25 basis points to 2.75%. That is in line with our expectations, roughly in line with what people were expecting them to do. The question is not so much what they would do this time around, but would they provide any signals as to how they are thinking about rates going forward? And on that, there was, of course, much less clarity on their part, because the reality is there is a tremendous amount of uncertainty about where the world is going to be a month or two or three from now. So just as it's just difficult for you and I to make an assessment of what the state of the world is going to be in, it's just as difficult for the governor of the Bank of Canada.

AL: Yeah, this must have been an incredibly difficult decision for the central bank in the midst of the very rapidly shifting tariff situation. Like at this point, some U.S. tariffs and some Canadian counter tariffs have been implemented. But the widespread 25% tariff have been pause for now. So, with all that in mind, you would say, is this the right call in your view? 

JFP: I think so. I mean, listen, there is, of course, a tremendous amount of uncertainty about what's going to happen on the tariff front. There is this April 2nd delay now for Canadian tariffs. We'll see if those come back on or not in a meaningful way. But in the meantime, even though there were some tariffs implemented to some degree already, the real challenge is uncertainty and how that's impacting Canadian households and businesses and that, of course, is having a damaging impact on growth. As people think about decisions a little bit differently and more nervous, more worried, hold off on some on some spending decisions, maybe worried about losing a job if things really turn sour. And same on the corporate side. You're getting a slowdown in economic activity or we expect to see a slowdown economic activity. So it's perfectly normal for the Bank of Canada to cut a little bit in that environment to try and soften that blow a little bit. Big question, though, is, of course, when those tariffs come into play in a meaningful way, so we have steel and aluminum tariffs that were put on today, you know in addition, some other tariffs were put on a little bit earlier. The net effect of all these tariffs as they are rolled out, of course, will be higher inflation. And that's, of course, the main consideration for the Bank of Canada. They are an inflation targeting central bank. They have a 2% inflation target. So there's a limit to what they can do to manage the downside impacts of uncertainty and kind of the disruptions tariffs pose against what is inevitably going to be an increase in inflation as those tariffs are rolled out in the U.S., as we retaliate on the Canadian side. And of course, that that pushes prices upwards. And that's something the governor has been very made very, very clear that he is very concerned about, that he will not let what we call a tariff shock become an inflation shock. He reiterated that today in his decision, something he said a few times before. And we expect him to continue to say that as we go forward, just because of the nature of this shock. Tariff shocks, they’re very challenging to manage. It's what we call a negative supply shock. So, you lower growth and raise inflation at the same time. And of course, for an inflation targeting central bank, that's a real tricky thing.

AL: Maybe let's set the table a bit in terms of let's take a closer look at inflation and where we're at now. Obviously, that was why the Bank of Canada had raised its rates so many times in order to rein that in. So maybe we could kind of go a little bit more into where we're at now. And the Bank of Canada did also put some survey data about how businesses and households are already reacting. So where are we at right now in terms of inflation and what has been the impact of tariffs or just the uncertainty of the trade situation thus far on inflation?

JFP: So, we're not seeing a whole lot related to trade actions on the inflation side yet, in large part because tariffs really haven't kind of had their impact yet. And of course inflation is always a little bit lagging. So we get inflation a month after the month is over, but the state of the union on inflation right now is it's roughly at target, roughly 2%. In some of the measures, inflation suggests maybe a little bit above 2% or maybe a little bit of a concern. But roughly 2%, which is, of course, what has allowed the Bank of Canada to lower rates as much as they have over the last year or so. So the question is not so much is inflation where it needs to be. The question is what is going to happen to inflation going forward? And in large part, a big part of that is what is going to happen is inflation expectations, right? How are people going to think about the impact of tariffs as, of course, if inflation expectations rise, then that puts upward pressure on inflation because, of course, firms anticipate those increases in inflation expectations and adjust their price accordingly. And that's also something the governor has been very clear about. They will be watching inflation expectations very, very seriously. And on that front, with the decision on Wednesday, they publish some off cycle survey information with respect to inflation expectations on the part of households and businesses. And they are picking up. They are picking up because people are worried about tariffs. We're seeing the same thing in the U.S., by the way. So this is not a uniquely Canadian perspective, but it does suggest that early in the day, inflation expectations are starting to rise, even though inflation's at 2%. And that's a real challenge or potentially a real challenge for the Bank of Canada because this is what we saw as being problematic in the pandemic. So we had, again, a supply shock, a negative supply shock. We were shutting down the economy for a period of time. We overstimulated coming out of that. And central banks around the world were saying the inflation that result from that was going to be temporary. Don't worry about it. It's going to be temporary. And inflation expectations were very slow to respond to that. But once people start to think this was no longer temporary, no longer transitory, we saw very significant increases in inflation expectations, which became very difficult for central banks to break, had to bring interest to 5% in Canada to get those under control. So that's a real linchpin of kind of the policymaking process on the central banking side in Canada is what are inflation expectations are going to do? How are they responding to all this stuff? And that will give you a very good indication of how seriously the Bank of Canada can put weight on the inflation outcome versus the growth outcome as those things deviate over the next few months.

AL: Macklem said during the press conference that the trade uncertainty alone is already causing harm. You have said before that the widespread 25% U.S. tariffs once imposed would certainly result in a recession in Canada. What about what's happening thus far? Just the various unknowns, the uncertainty. The data was already showing that there's a lot of already slowing in terms of activity, hiring. And those costs will, Macklem said, eventually get passed on to consumers. So, I guess I'm trying to get a sense of, even without the widespread 25% tariffs, is this uncertainty alone enough to result in some recessionary activity?

JFP: Well, we hope not. I mean the one thing to keep in mind is and we've seen this in the second part of last year, in fact, a little bit earlier this year as well, is that the Bank of Canada has been very, very aggressive in cutting interest rates, the most aggressive of all advanced economy central banks. The Canadian economy is probably the most sensitive to interest rate policy out of all advanced countries. So as a result of that, you've seen on the household spending side a very significant rebound in spending in the second part of last year and so far this year in terms of what’s available in terms of data. And we saw that largely speaking on the job side as well. So if you pretend that there's no Trump, if you pretend there’s no uncertainty, we would be going into 2025 with more momentum than expected. So that's carrying us to some degree so far in the year. But of course we can't pretend the uncertainty isn’t there because it is there. So as we think about the next few months, I mean, it's clear that activity is slowing. We don't have any firm indications of that yet. Economic data comes in with a lag, but it's clear in talking to clients at both corporates, households that there is a pull back in spending intentions. We see this in the Bank of Canada survey as well, and that should mean slower growth. Doesn't necessarily mean recession, but it should mean slower growth. And you know, the reality here is because we don't know really what's going to happen on the tariff side, it is possible that at the end of the day, we don't see many tariffs put on Canada. I mean, I don't know if it's likely or unlikely. It's extremely difficult to read the tea leaves on this coming from President Trump. But it's not impossible that we find ourselves a month or two from now with much greater clarity on the tariff side and maybe those tariffs aren't as bad as we fear. And you know that we come out of this with less harm than we are currently anticipating. But right now, I mean, this is very much a situation of peak uncertainty, right? We don't know if the tariffs are going to come on. We think they're going to come on. We don't know how long they're going to come on. If they do come on, how damaging those are going to be, how long will they last? What are we going to retaliate with? And that is symptomatic of the challenges that Canadians face. Americans are facing this as well. Europeans are facing this. But it is just this weight of uncertainty is unquestionably leading to lower growth than otherwise would be the case. There's no question about that.

AL: So what does all this mean for your outlook on rate cuts for the rest of this year? Is this the two cuts that we should expect or what do you foresee for the rest of the year?

JFP: I mean, this is not the kind of forecast that I like providing because it's so uncertain. But our perspective is the Bank of Canada is basically going to be in a holding pattern. They've cut to 2.75. They're going to stay there until we get greater clarity as to what happens either on the tariff side in the U.S., either on the retaliation front, on the Canadian side, and on the fiscal response in Canada. There will be a fiscal response if, in fact, tariffs do get thrown in a meaningful way at us. So government's going to help households and businesses manage the shock. So those three things are absolutely key to figuring out what the growth outlook is going to be going forward, how inflation responds, and of course, what the appropriate response from the Bank Canada is. So until we get clarity on that, it's very, very difficult to make a call. If you had to make me guess, do you think the balance of risks are to lower rates versus higher rates? I would say, yeah they're probably to lower rates relative to where we are now. But making that an explicit forecast at this point in time when there's so much uncertainty about how things are going to evolve on both sides of the border, you know, it's a bit of a fool's game, I think, at this point.

AL: On that note, I do have to ask again, because obviously there's so much uncertainty, it's hard to know. But I think this question would be on the minds of many Canadians who are potentially looking to renew their mortgages or buy a home. What are the chances at this point of an interest rate increase?

JFP: I think I think they're pretty remote. I mean, they're not zero, but they're pretty remote. And again, this is a function of how painful are the tariffs from an inflation perspective? How do people respond to those? Are they building expectation of much higher inflation? Do governments overstimulate as it did in the pandemic? So, I mean, the probability isn’t zero that we raise interest rates, but it's pretty low. And that's what I mean, that the balance of risk is more on the lower rate side going forward rather than the higher rate side. But you can't exclude, with a very low probability, that rates might actually have to go up at some point.

AL: So understandably, with all this uncertainty, a word we've used over and over again, tariffs, the volatile stock market, Canadians are worried. What would you tell them?

JFP: I mean, they're right to be worried. It is a deeply uncertain environment and nobody can provide much guidance as to how things are going to unfold because we just don't know. So it's normal for people to be anxious. It's normal for people to put off decisions, and that's probably the right thing to do. I mean, it might not be good for growth in the short run, but we are dealing with a very volatile situation. And you're better safe than sorry in this in this circumstance. Now, I think over the next few weeks, we'll probably have much more clarity as to the way forward and then it'll be a better time for people to make decisions. But at the moment, as I've indicated, it's peak uncertainty. There's just a lot of things up in the air and it's difficult to make sense of all that stuff. So in light of that, it does make sense to be a little more cautious than you otherwise would be.

AL: So overall, what are the main takeaways, in your view, for Canadians from the decision?

JFP: Well, one is clearly the Bank of Canada has got our back to some extent, right? So they cut interest rates today, even though there are concerns on the inflation side coming out of tariffs. And they've indicated that they would help the economy adjust to the extent that they can on that. There is clearly going to be fiscal support of some sort which will help households and businesses manage the shock. But this is occurring an environment of intense uncertainty, and that uncertainty hopefully doesn't last very much longer. There is this April 2nd in-principle deadline on the part of President Trump where he’s going to roll out the rest of the tariffs. We'll see if that's true or not. But as we get that certainty, as we get a better sense of what the landscape is, then it becomes much more easy to figure out where the economy is going to go and what are the risks around that. What's inflation going to do, how are central banks can respond. It's just that clarity for this particular point time is severely lacking.

AL Thank you so much again for coming back on the show to break down an increasingly complex situation for us.

JFP: You're very welcome. Thanks, Armina.

AL: I've been speaking with Jean-François Perrault, the Chief Economist at Scotiabank.