(Bloomberg) -- Bank of Canada Governor Tiff Macklem says the central bank can’t repair the economic damage of a trade war with the US — but he’ll do his best to make it less painful.
US President Donald Trump has threatened to impose tariffs of up to 25% on Canadian goods as early as Feb. 1. That would be a major hit to the Canadian economy, and higher import costs would also push up prices.
“A big increase in tariffs is a big disruption to the Canadian economy. Monetary policy can’t fix that,” Macklem said in an interview with Bloomberg News on Wednesday.
A trade battle, if it comes to pass, would mean the economy will work less efficiently, he said. Canadians will produce less and have lower incomes, and growth will be on a lower path.
Still, Macklem said the bank “can try to help that adjustment,” by making sure the economic shock is not more abrupt and painful than it has to be, and ensuring that the higher prices only cause “a temporary increase in inflation and that comes down reasonably quickly.”
And he didn’t rule out the bank acting to support the currency if it saw major “dysfunction” in markets.
The comments reinforce the central bank’s challenge as it prepares for an unknowable and potentially severe economic event. Earlier Wednesday, the central bank cut the benchmark rate to 3%, and Macklem made it clear there’s no obvious playbook if Trump carries out his threat.
Policymakers said they will be weighing the downward pressure on inflation from economic weakness against the upward pressure of higher input prices and supply chain disruptions — meaning the bank could either hike or cut rates depending on which force is stronger.
In the interview, Macklem said he expects to have more clarity on what’s happening with tariffs moving forward, and he’d be willing to provide an update to the outlook or some “additional written material” in a February speech or the March rate decision as more details emerge.
“I don’t think the first thing that is said is necessarily where we end up. This is going to be an evolving situation, and Trump does a good job of keeping everybody off kilter by saying lots of things.”
Crisis to Crisis
Macklem called the Covid-19 shock of 2020, the recovery and the once-in-a-generation spike in inflation “the biggest test our inflation targeting framework has had in 40 years.” And without the tariff threat, Canada’s outlook would be looking “pretty good.”
“Inflation’s come down, inflation is low, and we think it’s going to stay around our target. We think we have restored low inflation.”
On Wednesday, officials dropped any guidance on interest rates from their communications, evidence of the heightened uncertainty. “There’s too many things we don’t know to start giving forward guidance as to where we’re going,” Macklem told Bloomberg.
Macklem reiterated that he sees trade threats as having the largest impact on the depreciation of the loonie in recent months, although the the gap between the Canadian policy rate and the Federal Reserve’s interest rate policies is having some effect.
“When there’s more uncertainty, investors want to be compensated for that,” he said.
And while Macklem said he isn’t yet seeing any evidence of major disruptions in exchange rate markets, he didn’t eliminate the possibility of intervening to support the currency in that event — something the central bank did during the Asian crisis in 1997.
“When you get a more material movement in the exchange rate, of course we do need to take it more into account into our outlook,” Macklem said.
“We have not seen signs of any dysfunction or gapping, or jumps in the exchange rate. You go back to that period in the ’90s where there was some dysfunction and that’s why the bank stepped in. If we were to see that, we would take it very seriously.”
Macklem was already worried about the country’s weak level of business investment before the tariff threat emerged, but now he’s more concerned. Uncertainty is high, and a trade dispute has the potential to further reduce the productive capacity of the economy, limiting income growth.
The bank cut the contribution of investment to economic growth in the forecasts it released in its monetary policy report on Wednesday.
“If you don’t generate more income, you cannot consume more on a sustainable basis. And Canada is starting from a situation of high household indebtedness,” Macklem warned. “Raising household indebtedness is not going to be the solution to sustainably increasing our consumption.”
--With assistance from Randy Thanthong-Knight.
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