Case for BoC rate hike crumbling as trade war ramps up

The US-Canada trade war escalated again on Tuesday as Ottawa unveiled retaliatory tariffs on over $27 billion worth of US products and Donald Trump mulled attempting to rename Lake Ontario as “Lake America.”

The two sides are now locked in what could prove a lengthy and punishing trade standoff – and that could have big implications for the Bank of Canada’s approach to interest rates, with some economists viewing a hike in the months ahead as increasingly unlikely.

Before trade talks collapsed, financial markets saw a strong chance that the central bank’s next move would be to bring rates higher amid continuing concerns about an inflation flareup due to soaring oil prices.

But while he doesn’t expect the Canadian economy to take a huge hit from the latest round of US tariffs – which impact a swathe of Canadian products including alcohol, dairy goods, and wood and paper – Servus Credit Union chief economist Charles St-Arnaud said odds of a hike are rapidly falling.

“What [the trade war] really creates is that the probability of a hike… is very low, until probably spring next year,” he told Canadian Mortgage Professional. “And if there’s something like a new development, a new negotiation, and we get to an agreement that is actually beneficial for Canadians, I don’t see the Bank of Canada moving toward hiking interest rates.”

Economic concern outstrips inflation worries

Those inflation concerns haven’t vanished. The Iran war is rumbling on with no sign of a resolution, meaning upward pressure on oil prices is likely to continue, and tariffs and counter-tariffs usually pass higher goods costs on to the end consumer.

St-Arnaud, though, said the threat to the economy posed by the latest trade crisis will probably outweigh those fears, even if it also probably won’t spur the central bank into rate cuts.

“There’s always a concern about higher inflation coming from higher gasoline prices and energy prices, but we’re not seeing yet that second-round effect coming,” he said. “But I think the likelihood of hiking has been reduced significantly.

“Is it enough for them to go towards a rate cut? I think that will be more dependent on the data. We know it’ll be a headwind on the economy, but I don’t think the headwind is big enough yet for the Bank to be considering a move.”

The central bank’s next decision on interest rates is scheduled for next Wednesday (September 2), an announcement that’s still overwhelmingly expected to see the policy rate stay unchanged.

What’s next for the Bank of Canada?

Economists view a prolonged rate hold as the BoC’s most likely course of action, but Bank of Montreal (BMO) senior economist Robert Kavcic said its long-term outlook could be shifting because of the recent trade turmoil.

“The elevated uncertainty underlines the Bank of Canada’s inclination to remain on hold,” he wrote in an analysis this week. “Over the medium term, however, a weaker growth backdrop tilts the risks to a slightly more dovish skew, as the BoC specifically noted worsening tariffs as a potential reason to lower rates further.”

BMO still sees the BoC’s overnight rate staying at 2.25% through the rest of this year, “but the dovish argument just got stronger.”

Toronto-Dominion (TD) Bank director and senior economist Andrew Hencic also said the threat to the economy seems to be overtaking inflation concern in the central bank’s thinking.

“For the BoC these latest developments reinforce their stand-pat stance,” he said. “Trade uncertainty remains elevated, with the downside risks to growth on the forefront.”

Canadian Imperial Bank of Commerce (CIBC) economists Avery Shenfeld and Andrew Grantham noted that previous retaliatory tariffs by Canada “ended up only adding a few decimal places to the CPI at their peak impact,” signalling that a fresh inflation uptick doesn’t seem likely from the latest measures.

“We would expect a similarly minimal inflation impact in this case,” they wrote, “and therefore, a potential for this trade-war escalation to keep interest rates low for longer if growth is negatively impacted.”

Source CMP
By Fergal McAlinden