Bank of Canada holds interest rate at 2.75%, says trade war could cause a recession

The Bank of Canada on Wednesday held its key policy rate at 2.75 per cent, its first pause after seven consecutive cuts, and said the uncertainty around U.S. tariffs made it impossible to issue regular economic forecasts.

Instead, the central bank produced two scenarios on what could happen, including one that predicted a deep recession in Canada and a spike in inflation.

Governor Tiff Macklem said the bank — which began cutting last June — had kept interest rates on hold as it gained more information on the impact of tariffs and would proceed carefully.

“A lot has happened since our March decision five weeks ago, but the future is really no clearer. We still do not know what tariffs will be imposed, whether they’ll be reduced or escalated and how long all of this will last,” Macklem said in his opening remarks after the rates decision was announced.

“That means being less forward-looking than usual until the situation is clearer.”

The bank’s monetary policy would ensure inflation remained under control and would support economic growth, Macklem said.

Economists construed the governor’s commentary as an indication that the bank’s current pause was not an end to the easing cycle and that it would jump in to support the economy if needed.

“He’s clearly laid open the possibility of getting a lot more aggressive if the economy deteriorates substantially,” Douglas Porter, chief economist at BMO Capital Markets, said.

Andrew Kelvin, head of Canadian and global rates strategy at TD Securities, said that going forward, the weakness is expected to pile up in the economy and that would force the bank to cut rates again.

In the near term, the central bank expects second-quarter GDP to be much weaker, after a 1.8 per cent growth forecast for the first quarter. Inflation is seen dipping to about 1.5 per cent in April, mainly due to the removal of carbon taxes and lower crude prices.

The central bank said it was difficult to predict the path of the economy for the long term.

“Forecasts for economic growth are of little use as a guide to anything,” Macklem said.

Two possible scenarios

For the first time since the COVID-19 pandemic, the Bank of Canada scrapped the economic forecasts it gives in a quarterly monetary policy report. It instead offered two possible scenarios.

The first scenario assumes most of the tariffs are eventually withdrawn through negotiations, which would stall GDP in the second quarter. The economy then expands moderately, while inflation sinks to 1.5 per cent before returning to the two per cent target.

In the second scenario, the bank assumes the tariffs spark a long-lasting global trade war. In this case, the Canadian economy goes into a significant recession for a year, while inflation spikes to 3.5 per cent in mid-2026.

Macklem said under this scenario, U.S. tariffs would permanently reduce Canada’s potential output and lower the country’s standard of living.

This kind of outcome would be “painful” for Canada, he said in a press conference following the announcement. Some exporters could go bankrupt, unemployment would rise and Canadians might have to cut back on their spending under that second scenario.

Macklem added that if the incoming information points clearly in either direction, the bank is ready to act decisively.

The governor also said these scenarios were two possibilities and they don’t span the possible outcomes. “The message here is we have got to be flexible and adaptable,” he said.

Canada’s economy, which had been teetering for most of last year, found its footing as 2024 was ending.

But U.S. President Donald Trump’s decision to unilaterally slap a barrage of tariffs on Canada and Mexico, followed by the rest of the world, has dented business investments and consumer spending.

This is evident in the recent hard data that showed lack of job growth, elevated inflation and weaker economic growth.