MNI INTERVIEW: BOC To Cut More, Wary Of Inflation- Ex Staffer

The Bank of Canada will further cut interest rates this year as a trade war with the U.S. stifles investment and immigration falls, but it will also cast a more watchful eye on inflation in case it rises back above target, former BOC economist Charles St-Arnaud told MNI.

U.S. threats of tariffs are already hurting investment in Canada, and even if Donald Trump backs off there will be permanent damage, St-Arnaud said.

“Uncertainty is the killer right now, it’s changing investment patterns,” he said. "Uncertainty is probably part of Trump’s strategy [because for the U.S.] it’s like putting on the tariff, but you don’t have the inflation cost.”

Canadian domestic demand will also be stifled by the government’s move to curb record immigration, which will tend to lower the neutral interest rate. This means that the Bank’s latest cut to what it considers neutral at 2.75% on Wednesday will leave it in restrictive territory later this year, St-Arnaud said.

"They will have to cut for that, just to make sure that monetary policy stays neutral," he said. 

ALREADY PERILOUS SITUATION

Finally, incoming Prime Minister and former BOC Governor Mark Carney will understand that while he can’t rely on the central bank to provide all the stimulus, fiscal policy can’t return to blanket income support used during the pandemic, St-Arnaud said. “In aggregate, rates are going to be lower by the end of the year, that’s almost a certainty,” said St-Arnaud, also a former finance department economist and now chief economist at the Alberta Central credit union. 

He provided no point estimate for the year-end rate given the fluid trade tensions, but suggested more than one cut will be needed. Economists surveyed by MNI after Wednesday's decision are split between whether one, two, or three more cuts are coming in 2025. 

Vivek Dehejia, a Carleton University trade economist whose doctoral advisers were Jagdish Bhagwati and Nobel Laureate Robert Mundell, told MNI there is limited scope for fiscal and monetary stimulus. "This is going to be a dilemma for both the federal government and the Bank of Canada," he said. (See: MNI: Carney To Take On Trump, Be Fiscally Cautious - Ministers)

"Ramping up spending to help offset the damaging effects of tariffs would make an already parlous fiscal situation even worse," he said. "Likewise, the central bank has the difficult dilemma that if Canada slides into stagflation because of the tariffs... cutting rates to boost the economy will further exacerbate inflation, whereas raising rates to fight rising prices will further worsen the economic slowdown."

TEMPORARY TARIFF INFLATION

St-Arnaud suggested near-term momentum to extend the Bank's seven cuts since June will be clouded by the temporary price boost from tariffs and the government's tax holiday late last year. "If those inflation pressures -- or the momentum -- is still close to 3%, they will start to be a bit more on the fence between cutting and holding," he said. Headline inflation was 1.9% in January and core indexes were 2.7%. 

“I have a feeling a lot of the inflationary pressure on tariffs will be temporary,” he said. The Bank appears to be too afraid of again being caught in an inflation surge as was the case following the pandemic, he said. Other experts also say the Bank may react too slowly to turning points. (See: MNI: Bank Of Canada Is Lagging On Rate Cuts- CD Howe) 

There's reason to believe other inflation hotspots will cool down and provide space for further cuts, St-Arnaud said. Canada’s dollar has been stable lately, suggesting less upward pressure on import prices, and threats of layoffs linked to the trade war will also cap recent outsized wage demands, he said.