(Bloomberg) -- The Bank of Canada made clear that central banks around the world are fighting an entirely different war than the pandemic — but post-Covid inflation fears are haunting policymakers as they try to protect their economies from US President Donald Trump’s tariff barrage.
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On Wednesday, Governor Tiff Macklem called the trade battle between the US and Canada a “new crisis,” and officials cut borrowing costs by a quarter percentage point to counter “pervasive uncertainty.” At the same time, officials tempered expectations for further reductions, saying they’d “proceed carefully” with any future changes to interest rates.
The bank’s dilemma captures the challenge faced by central bankers as they weigh responses to Trump’s unpredictable trade announcements. Inflation, not damage to economic growth, will dictate the extent to which they can offer help this time around.
After being slow to catch the run-up in prices during the pandemic recovery, monetary policymakers must now judge the potential impact of levies, currency movements and slowing demand. Trump’s frequent tariff changes add to forecasting woes.
“There are a number of new costs that businesses are facing, and ultimately those will get passed through to the prices that Canadians face,” Macklem told reporters after the decision. “We don’t want to see that first round of price increases have knock-on effects, causing other prices to go up, becoming generalized and ongoing inflation. That’s what we can’t let happen.”
Inflation risks posed by the tariff feud mean a prescription of deep and steady rate cuts akin to the Covid-19 response isn’t in the cards. Instead, economists expect cautious fine-tuning, with the bank cutting the benchmark rate from 2.75% now to between 2% and 2.25% this year.
“There won’t be a race to the bottom for interest rates this year,” Claire Fan, senior economist with RBC Capital Markets, wrote in a report to investors.
The yearly change in inflation rates may be falling, but purchasing power has been eroded, and it has left citizens in some countries angry enough to oust incumbent governments. Central banks need to heed that sensitivity to price changes.
“Keeping medium- and longer-term inflation expectations well anchored is imperative to ensure any rise in inflation is temporary,” Macklem said. The bank also took the unusual step of offering up fresh survey data on the issue, which showed businesses and consumers already expecting higher prices. CPI inflation rose at a 1.9% yearly pace in January, just under the bank’s 2% target.