Market News

"Monetary policy cannot compensate for the structural damage caused by tariffs": Macklem

John MacFarlane, Jeff Lagerquist and Leah Golob

The Bank of Canada (BoC) held its overnight interest rate at 2.25 per cent on Wednesday, in a move widely expected by economists. The announcement made clear that “heightened uncertainty,” with the Canada-U.S.-Mexico Agreement (CUSMA) in focus, clouded any future decisions.

“While Council judges the current policy rate is appropriate based on our outlook, the consensus was that elevated uncertainty makes it difficult to predict the timing or direction of the next change in the policy rate,” Governor Tiff Macklem said in remarks about the rate decision.

Economists singled out the BoC’s studied ambiguity, with TD’s Andrew Hencic noting that “the emphasis on uncertainty in the statement was prominent.” Most see the central bank remaining in a holding pattern until the outcome of CUSMA negotiations is clear or other economic data offer strong evidence for a move.

“It's clearly going to require a material shift in the outlook to prompt a change in rates, but given the highly uncertain trade backdrop, a material shift is quite possible,” BMO chief economist Douglas Porter wrote in a note to clients.

Porter and others suggest that a future cut seems to be a more likely scenario at this stage, with Porter noting a “subtle shift” in the Bank’s reference to inflation. The BoC now says inflation is "close to the two per cent target" rather than the previous "around 2.5 per cent" — implying a lower level of concern.

That and the projections in the BoC’s latest Monetary Policy Report (MPR), which outlines its outlook for the economy, are aligned with Desjardins Group’s “expectation that the Bank of Canada would sound less concerned today about upside risks to inflation and more concerned about downside risks to growth,” economist Royce Mendes says.

RBC economist Claire Fan says "the case for further easing is weak." Scotiabank's view remains for a hold in the first half of 2026, with a more tentative call for two rate hikes at the end of the year.

In the news conference, Macklem and senior deputy governor Carolyn Rogers sought to define the extent of the uncertainty guiding the BoC’s decision-making. “Just when we think we've thought of everything that could possibly hit us, something new happens,” Rogers said.

“In order to assign probabilities as to the direction of the next move in the interest rate, you need to be able to assign probabilities to the risks,” Macklem said. “We are monitoring those risks very closely, and if a new shock comes along or an accumulation of evidence that materially changes our outlook, we're prepared to respond. So, you know, we are very alive to those risks.”

Macklem, however, took pains once again to note the BoC’s limitations in dealing with trade shocks. "Monetary policy cannot compensate for the structural damage caused by tariffs, and it can't target hard-hit sectors of the economy, but it can play a supporting role, helping the economy through this period of structural adjustment while maintaining inflation close to the two per cent target," he said.

Adding to the complex global backdrop, Macklem highlighted potential threats to the independence of the Federal Reserve as another layer of risk.

“The Federal Reserve is the biggest, most important central bank in the world, and we all need it to work well,” he said. “A loss of independence of the Fed would affect us all, and for Canada, our financial markets are particularly integrated with the United States, so it would particularly affect us.”

MPR: Growth patterns 'quite volatile'

The January MPR, which includes a section outlining multiple possibilities for the CUSMA negotiations, describes an economy that “likely stalled” in late-2025 — weighed down by an unemployment rate of 6.8 per cent — and is projected to grow at a “modest” 1.1 per cent in 2026.

While inflation is expected to remain close to two per cent, the outlook relies on a balance of opposing forces: the "downward pressures from excess supply" in the economy are expected to roughly offset "upward pressures related to trade reconfiguration." The report notes that this environment has made growth patterns "quite volatile," with activity driven by "large swings in trade and inventories" rather than steady demand.

The Bank estimates that U.S. tariffs will have a "persistent negative impact," reducing GDP by approximately 1.2 per cent by the end of 2026 compared to prior forecasts. As businesses work on "reconfiguring their trade" and "seeking new suppliers," the MPR warns that uncertainty remains high and growth will be "restrained through the transition.”

Ahead of the announcement, economists polled by Reuters were unanimous in their expectations for a hold today, and nearly 75 per cent forecast the central bank will stand pat through 2026.

In its December decision, the Bank also kept its policy rate stable