Canada’s Soft Landing in Jeopardy as Macklem Faces Trump Tariffs
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Canada’s Soft Landing in Jeopardy as Macklem Faces Trump Tariffs
Erik Hertzberg
4 min read
(Bloomberg) -- Governor Tiff Macklem has successfully wrestled down one of the worst inflationary crises in the Bank of Canada’s history, putting his nation on track for a soft landing. US President-elect Donald Trump may dismantle all that with a stroke of a pen.
Trump’s threat to impose 25% tariffs on all Canadian goods, which he may try to carry out quickly through an executive order, would almost surely send the country into a deep recession. Nearly 2 million workers are employed in industries dependent on US demand for Canadian exports; the provinces of Ontario and British Columbia have estimated combined job losses of more than 600,000.
While it remains unknown whether Trump will inflict such extreme economic pain on the country — he may opt instead for gradual tariffs that begin at a lower rate and ramp up over time — Canada’s central bank is facing a period of grave uncertainty. And it comes just as inflation finally seems comfortably back to the 2% target, and as the labor market appears to be rebounding.
Now, Macklem must pivot to tackling an unknowable and incalculable risk. Prime Minister Justin Trudeau’s government has said it’s preparing broad retaliatory tariffs if Trump starts a major trade war, which would deepen the hit to Canada’s gross domestic product but aim to pressure Trump to lift his tariffs more quickly.
But a tariff battle may also be inflationary in the short term, making the path of interest rates unclear. Deputy Governor Toni Gravelle said Thursday the economic damage also depends on how each country spends potential tariff revenues, and whether they’re used to support consumers and businesses or pay down debt.
A tariff war that includes retaliation from Canada means “there’s likely to be an inflation impact at the same time that we have a slowdown in the economy, so that puts the central bank in a very complicated space,” Gravelle said.
Gravelle said the central bank will provide more analysis of potential scenarios in the bank’s monetary policy report, which will be released on Jan. 29 alongside an interest rate decision.
In 2019, before Macklem became governor, the bank modeled a downside scenario similar to the present risk, where the US applies 25% tariffs and faces an equal response from its affected trading partners.
Canada’s GDP would take a 6% hit, the bank estimated at the time. That would be a bigger drop in GDP than in any recession excluding the downturn that coincided with the Covid-19 shock. The loonie would also depreciate by 25%, the bank’s analysts said at the time.
Higher import costs, driven in part by the weaker loonie, would also push prices up in the northern nation. Coupled with the weaker growth and an export sector reeling from lost American 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 grim picture for Canada,” Matthieu Arseneau and Stéfane Marion, economists at National Bank, said in a report to investors. “Exports and investment would take a significant hit, while consumption would weaken due to deteriorating labor market conditions and adverse terms of trade.”
Inflation Expectations
Unlike the Federal Reserve, the Bank of Canada’s sole mandate is keeping the yearly change in the consumer price index at 2%.
If Trump levies tariffs and Canada responds in kind, policymakers’ first task is likely communicating to the public that the jump in prices would be temporary, Paul Beaudry, who served as a deputy governor at the bank until mid-2023, said in an interview.
That means assuring businesses and consumers they shouldn’t be building price changes into their beliefs about future inflation and wage and compensation plans. Consumers’ inflation expectations have nearly returned to normal after one of the steepest run-ups in inflation in four decades.
“Hopefully that message gets across. If it doesn’t and inflation expectations start de-anchoring like they were doing at the end of 2021, then rates would have to go up,” said Beaudry, adding that the resulting economic slowdown and fall in demand may not be sufficient to drag prices lower.
Government officials told Bloomberg that they’ve already prepared lists of US products that would face counter tariffs, potentially a “dollar-for-dollar retaliation” that’s more extensive than in 2018, when Trump targeted a narrower set of Canada’s exports.
The federal government is also likely to set its fiscal policy to support exporters and other hard-hit sectors. Statistics Canada estimates 8.8% of Canadian workers depend on US demand, and Trudeau has already suggested tariff revenue may be quickly redirected to mitigate economic impacts to workers and businesses.
Government spending should tilt away from stimulating consumption, and focus instead on boosting investment and lagging productivity, said Jeremy Kronick, vice president of economic analysis and strategy at the C.D. Howe Institute. Provincial governments could focus on reducing existing trade barriers within the country, too.
“If all the government does is hands out checks to people, it’s just going to further boost inflation. So that’s not the solution,” he said.
