Trade War Boosts Inflation Expectations, Bank of Canada Says

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Mon, Apr 7, 2025, 8:09 AM 4 min read

Canadian business sentiment deteriorated in the first quarter, the bank’s survey of firms showed Monday. The outlook indicator fell to minus 2.14 from minus 1.16 at the end of last year, reversing an improving trend seen over the past two quarters. Firms’ sales outlook has softened, and investment and hiring plans are being put on hold.

For the first time in more than two years, businesses no longer expect growth in their input prices to slow. Two-thirds see their costs pushed higher in the event of widespread tariffs, and many say they would increase their selling prices. Tariffs are also seen adding to existing pressures from a weaker Canadian dollar making imports more expensive.

Governor Tiff Macklem and his central bank officials are weighing whether to pause their easing campaign or cut interest rates for an eighth straight meeting on April 16. Some economists see them stepping to the sidelines due to uncertainty, while others expect them to proactively reduce borrowing costs to prop up the economy during the tariff war. A multi-day selloff in global financial markets has boosted traders’ bets on a rate cut.

The report points to a rapidly worsening outlook for inflation and growth. The bank conducted the survey of businesses between Feb. 6 and 26, before US President Donald Trump imposed steep duties on the Canadian steel, aluminum and auto sectors as well as on products that aren’t compliant with rules under the US-Mexico-Canada trade agreement. The Canadian government also hit back in kind.

Firms attribute a substantial portion of price increases to Canada’s retaliatory levies. But while US tariffs on Canadian goods are imposed on American importers, some exporters in Canada are sharing some portion of the levy costs with their customers to maintain market share.

Businesses’ near-term inflation expectations have increased considerably since last quarter. Longer-term expectations, however, remain largely unchanged.

Some 22% of firms said uncertainty was holding back their investment plans, the highest on record in data going back to 2017.

“The inflation worries make the case for a pause, while slowing growth makes the case for a cut,” Benjamin Reitzes, rates and macro strategist at Bank of Montreal, said in an email. “With 225 basis points under their belt in total cuts already, of which 50 basis points was for risk management, we’d still lean toward a pause for now, but it’s a close call, especially if risk assets continue to melt down.”

Consumers also expect tariffs to lead to a higher cost of living. Their short-term inflation expectations rose in the first quarter, the first increase since 2022, according to the bank’s accompanying consumer survey, which was taken from Jan. 29 to Feb. 25. Expectations for inflation five years from now edged up slightly.

Canadians view tariffs and the loonie-greenback exchange rate as the “most important factors” hindering the bank’s ability to control inflation. But most consumers expect the inflationary impact of tariffs to last less than five years, a shorter duration than the impact of domestic government spending and housing costs.

The rise in inflation expectations should push the Bank of Canada to hold off on providing additional monetary easing next week, Royce Mendes, head of macro strategy at Desjardins Securities, said in a report to investors.

“The tariff situation remains very fluid and, unless financial system functioning begins to deteriorate, central bankers are unlikely to be in a position to cut rates in the near-term,” he said.

Confidence in the labor market has weakened sharply and consumers are more pessimistic about their financial health. Canadians working in trade-dependent sectors are most worried about losing their jobs. As a result, consumers now intend to spend more cautiously.

Many consumers expressed a desire to prioritize Canadian goods, either to support the local economy or as a protest against the Trump administration’s actions, the bank said. But while some of them were willing to pay a bit more for Canadian goods, others said their cost of living is too high for them to afford the higher prices of local goods.

--With assistance from Erik Hertzberg and Mario Baker Ramirez.

(Adds reaction from economists starting in the ninth paragraph.)

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Trade War Boosts Inflation Expectations, Bank of Canada Says

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