Canada’s Soft Landing in Jeopardy as Macklem Faces Trump Tariffs

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(Bloomberg) — Governor Tiff Macklem weathered one of the worst inflationary crises in the history of the Bank of Canada, putting his country on track for a soft landing. Perhaps US President-elect Donald Trump will dismantle all of this with the stroke of a pen.

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Trump’s threat to impose 25% tariffs on all Canadian goods, which he may try to quickly implement through executive order, would almost certainly push the country into a deep recession. Nearly 2 million workers are employed in industries that depend on American demand for Canadian exports. Together, Ontario and British Columbia estimated job losses at more than 600,000.

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While it remains unknown whether Trump will inflict such severe economic pain on the country — he may instead choose to impose gradual tariffs that start at a lower rate and escalate over time — Canada’s central bank faces a period of extreme uncertainty. It comes at a time when inflation appears to have finally returned comfortably to the 2% target, and while the labor market appears to be rebounding.

Now, Macklem must focus on tackling countless unknown risks. Prime Minister Justin Trudeau’s government said it is preparing for broad retaliatory tariffs if Trump starts a major trade war, which would deepen the hit to Canada’s gross domestic product but is aimed at pressuring Trump to raise his tariffs more quickly.

But the tariff battle may also be inflationary in the short term, leaving the path for interest rates unclear. Deputy Governor Tony Gravelle said Thursday that the economic damage also depends on how each country spends potential tariff revenue, and whether it is used to support consumers and businesses or pay down debt.

A tariff war that includes retaliatory measures from Canada means “there will likely be an inflationary impact at the same time that we see a slowdown in the economy, and that puts the central bank in a very complex space,” Gravelle said.

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Gravel said the central bank will provide further analysis of possible scenarios in the bank’s monetary policy report, which will be released on January 29 alongside the interest rate decision.

In 2019, before Macklem became governor, the bank modeled a similar bearish scenario for current risks, in which the United States applies 25% tariffs and faces a similar response from its affected trading partners.

The bank estimated at the time that Canada’s GDP would take a 6% hit. This would be a larger drop in GDP than any recession except the one that coincided with the Covid-19 shock. The value of the Canadian dollar would also fall by 25%, the bank’s analysts said at the time.

Higher import costs, driven in part by a weaker Canadian dollar, would also push up prices in the Nordic nation. Coupled with weak growth and an export sector suffering from the loss of US customers, the resulting stagflation — rising prices and a deep hit to growth — would limit the Bank of Canada’s response.

The central bank’s 2019 estimates “paint a bleak picture for Canada,” Mathieu Arsenault and Stéphane Marion, economists at the National Bank, said in a report to investors. “Exports and investment will take a major hit, while consumption will be weakened by deteriorating labor market conditions and adverse terms of trade.”

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Inflation expectations

Unlike the Federal Reserve, the Bank of Canada’s sole mandate is to keep the annual change in the CPI at 2%.

Paul Beaudry, who served as deputy governor of the bank until mid-2023, said in an interview that if Trump imposes tariffs and Canada responds in kind, the first task for policymakers will likely be to inform the public that the jump in prices will be temporary. .

This means reassuring businesses and consumers that they should not base price changes in their beliefs about future inflation and pay and compensation plans. Consumer inflation expectations have almost returned to normal after one of the largest inflation increases in four decades.

“We hope this message gets across. If not and inflation expectations start to decline as they did at the end of 2021, interest rates will have to rise,” Beaudry said, adding that the resulting economic slowdown and reduced demand may not be enough to impact the economy. Lower prices.

Government officials told Bloomberg they have already prepared lists of U.S. products that would face counter-tariffs, potentially more sweeping “dollar-for-dollar retaliation” than in 2018, when Trump targeted a narrower set of Canadian exports.

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The federal government is also likely to position its fiscal policy to support exporters and other hard-hit sectors. Statistics Canada estimates that 8.8% of Canadian workers depend on U.S. demand, and Trudeau has already suggested that tariff revenues may be quickly redirected to mitigate the economic impacts on workers and businesses.

Jeremy Kronick, vice president of economic analysis and strategy at the CD Howe Institute, said government spending should shift away from stimulating consumption and instead focus on boosting investment and lagging productivity. Provincial governments could focus on reducing trade barriers within the country as well.

“If all the government does is distribute checks to people, that will increase inflation. So that is not the solution,” he said.

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