Bank of Canada Governor Tiff Macklem speaks at the Greater Vancouver Board of Trade in Vancouver, Dec. 16, 2024.ETHAN CAIRNS/The Canadian Press
Across-the-board, 25-per-cent U.S. tariffs, along with retaliation, could send the Canadian economy into a recession and drive up inflation within the first year of a trade war, according to a new analysis from the Bank of Canada.
In its quarterly monetary policy report released Wednesday, the central bank didn’t include tariffs in its baseline economic projections and acknowledged its figures are subject to significant uncertainty due to the Trump administration’s looming tariff threat.
Instead, it simulated the potential impact of 25-per-cent tariffs on all goods the U.S. imports, including from Canada, as well as retaliatory tariffs from trading partners of the same magnitude on U.S. imports. That modelling suggests growth in Canada could be up to 3 percentage points lower in the first year of a trade battle. The effect of tariffs on growth tapers out in the second and third years of tariffs.
Its baseline economic projection, which doesn’t include U.S. tariffs, points to 1.8-per-cent growth in real gross domestic production in both 2025 and 2026.
The central bank’s tariff simulation suggests if the economy responds in line with historical patterns, inflation would be 0.1 percentage points higher in the first year tariffs are implemented, then 0.5 and 1 percentage points higher in the second and third years.
However, faster pass through of costs to consumers could increase inflation by 0.8 percentage points in the first year, and by 1.3 and 0.6 percentage points in the second and third years.
Governor Tiff Macklem said the central bank’s simulation shows that 25-per-cent tariffs would have a “severe effect” on economic activity. But how U.S. demand responds to Canadian exports, as well as how quickly and to what extent higher costs get passed down to Canadian consumers, will determine to what extent a trade war affects the economy, the governor noted.
“We don’t have a lot of good historical examples where we’ve had tariff shocks of this magnitude,” Mr. Macklem said in a news conference. “Exactly how quickly, how big, how people react, what the implications are for inflation – there is a certain zone of uncertainty.”
The hypothetical analysis comes as U.S. President Donald Trump threatens to impose 25-per-cent tariffs on all Canadian imports starting Feb. 1. The Bank of Canada, which lowered its policy interest rate by a quarter percentage point Wednesday, conceded the central bank’s ability to respond to the economic impact of tariffs would be limited.
“Unfortunately, tariffs mean economies simply work less efficiently – we produce and earn less than without tariffs. Monetary policy cannot offset this,” Mr. Macklem said.
“What we can do is help the economy adjust. With inflation back around the two-per-cent target, we are better positioned to be a source of economic stability. However, with a single instrument – our policy interest rate – we can’t lean against weaker output and higher inflation at the same time.”