March 14, 2025 | Interest Rate Cuts Won’t Be Enough To Save The Canadian Economy

Canadian central bankers cut their official rate by ¼ of a percent on Wednesday this week. But that won’t be enough to boost the economy in the face of higher tariffs and repeated threats from the U.S. President.

How bad will the downturn get?

Tiff Macklem and his colleagues at the Bank of Canada did what they had to do and cut interest rates by a modest amount. This seventh interest rate cut takes the rate to 2.75 percent, down from 5.25 percent before cuts began in May 2024.

He stated that progress on inflation has been good, but he expects inflation will rise. Tariffs will bring higher prices. The lower Canadian dollar will push inflation higher as the cost of imported goods rises. The hawkish tone of his remarks emphasized the need to restrain inflation more than promoting growth. The Loonie gained more than 50 basis points after his remarks.

Interest rate cuts stimulate primarily through housing. A rise in housing purchases caused by lower rates increases construction employment (1.5 million jobs), house prices rise, and consumers spend more due to the wealth effect. The monthly cost of homeownership falls as the mortgage expense is tied to interest rates. But housing will not rescue Canada from a recession caused by uncertainty over slumping exports and rising tariffs.

And it’s not only homebuyers who are hesitating. Business investment is a substantial portion of GDP but experiences wide swings as decisions are made based on the outlook for profits. If the outlook is too uncertain business investment can drop dramatically, unlike consumer spending which is more stable.

One of the attractions of investing in Canada is its close relationship with the much larger market in the U.S. and the USMCA trade agreement signed in 2018 between Canada, the U.S. and Mexico. But that advantage may be ending as Trump’s tariffs violate the agreement, but Americans are not concerned. Why risk building a plant in Canada to sell into the U.S. when you can build in the U.S. instead?

Macklem emphasized price stability as his main priority. But depending on the depth of the inevitable recession the central bank may not have to raise interest rates to keep prices from going much higher. A recession could be enough to hold prices level or even cause deflation. He mentioned “we can’t lean against weaker demand and higher inflation at the same time” — hinting that the Bank’s main policy goal will continue to be preserving the purchasing power of the currency.

Canadian consumers will cut back on spending as they feel the impact of higher prices and because they are worried about job security.

Businesses are trying to find ways to avoid tariffs and to manage their supply chains. They won’t be building new plants in Canada, and expansion plans will stay on hold.

In summary, the next recession will be worse than any since the 1990s. Canadian should prepare for a sharp slowdown and a long and bumpy recovery.

Hilliard MacBeth

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Hilliard MacBeth March 14th, 2025

Posted In: Hilliard's Weekend Notebook

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