MNI INTERVIEW: Supply Damage Supports BOC Hold- Dal's McNeil

Canada's central bank can avoid cutting interest rates further even if the U.S. trade war continues hitting growth with tariffs also disrupting supply and keeping inflation pressures balanced, a professor who has worked with former BOC advisers and did PhD research there told MNI.

"One really interesting point I think that the Bank has made, actually a couple times, and I'm not sure people are picking up on it as much, is the all the effects of these tariffs on potential (growth) in Canada," said James McNeil, a Dalhousie University economics professor.

"If we have less trade, potential output is lower," he said in an interview. "We might observe declines in GDP that they wouldn't necessarily feel that they need to respond to because they don't think that it's a typical recession." (See: MNI INTERVIEW: Further BOC Cut Unclear In Trade War Fog-Mendes)

Governor Tiff Macklem on Wednesday lowered the policy rate 25bps to 2.25%, the bottom of its estimated neutral range, and said the rate may hold for a while if the Bank's forecast is realized. The Bank estimates growth of less than 1% in the second half of the year following a second-quarter contraction and a similar gain of 1.1% next year, keeping inflation around the 2% target. 

DEMAND SIDE STORY

Economists surveyed by MNI are split with 10 saying the Bank will remain on hold and another 10 seeing a cut by early 2026. The risk is much more the Bank cutting again while chances of a hike being the next move are remote, McNeil said. 

The propensity to possibly cut further is reinforced by McNeil's view that for now, despite the supply-side element to the trade war, "what declines we're seeing in the Canadian economy are mostly a demand side story." He didn't give a prediction of the length of a pause or any next move. 

Deficit spending in Prime Minister Mark Carney's federal budget Tuesday will fill some of the gap in demand created by U.S. tariffs, he said. Macklem told reporters monetary policy has done about all it can do for the handful of industries hurt by tariffs. McNeil said that sends a signal of a green light for a big deficit rather than a Bank warning deficits will feed inflation at a time when core prices are still advancing at 3%. 

While Donald Trump's trade threats have been volatile, the current effective tariff rate is only about 5% because many firms are using an exemption under USMCA, another reason McNeil said Macklem can sound more neutral. 

ANOTHER TAILSPIN?

"If we start to see higher tariff rates across the board, well that would be definitely something that would be throwing the Canadian economy into another tailspin," he said. (See: MNI INTERVIEW: Canada Truckers See Worst Slump In Four Decades)

"What they're thinking is we wouldn't want to necessarily lower interest rates in a world like that, because if there's just less potential output in the economy, right? You can't magically produce more output with monetary policy. You're just going to run out prices," McNeil said. "Maybe you shouldn't necessarily expect in future interest-cuts, even if trade continues to be a drag." 

Canada’s resilient dollar is an important piece of the growth and inflation outlook as well, he said when asked about the currency’s relative strength this year. U.S. policies have hurt perceptions of both Canada’s and America’s economy, he said, a different situation from past instances where the Canadian dollar tumbled as investors saw the United States as stronger, he said.

On the Bank's framework review next year, McNeil said officials have a communications challenge around core inflation and the shift to an undefined measure of trend inflation over its previous core indexes. Similar to what other sources have told MNI, McNeil says the problem is one measure is not robust to all situations. 

"They have all this information, they've got even more measures probably behind the scenes that they don't share online or tell us about necessarily. But it is useful when they're explaining their decisions to sometimes point to these measures."