Bank of Canada signals shift in how it sets rates amid tariff uncertainty

Original Publication Date March 20, 2025 - 10:11 AM

OTTAWA - The head of the Bank of Canada has signalled a shift in how the central bank sets its benchmark interest rate at a time when tariff uncertainty with the United States has made long-term forecasting much more difficult.

Governor Tiff Macklem was in Calgary on Thursday speaking to the city's economic development group.

The Canadian economy was in a strong position at the start of 2025 as inflation was under control and growth was picking up, he said in prepared remarks for the speech.

With the central bank’s benchmark interest rate quickly returning to lower levels, it appeared as though Canada had managed to avoid a recession.

“The Canadian economy managed a soft landing. Unfortunately, we’re not going to stay on the tarmac for long,” Macklem said.

That’s largely because of sweeping tariffs imposed by the United States earlier this month, as well as the Canadian response to impose import taxes on billions of dollars in U.S. goods.

“The damage caused by tariff uncertainty has started on both sides of the border,” Macklem said.

Because of that uncertainty, Macklem signalled a shift to how the central bank will approach the economic forecasts it uses to decide where to take its policy rate, which sits at 2.75 per cent after seven consecutive cuts.

Tariffs have been imposed and changed multiple times so far this month, and it’s not fully clear where U.S. President Donald Trump will take the trade dispute next, though he has threatened another round of “reciprocal” tariffs is coming on April 2.

Macklem has warned in the past that the Bank of Canada's tool box isn't well-suited to tackle both higher inflation and the hit to the Canadian economy from the tariff battle at the same time.

Rather than the governing council’s typical approach of agreeing on an economic forecast and setting monetary policy along that path, Macklem said monetary policymakers will now focus more on setting a rate that’s better suited for the range of risks facing Canada.

By doing so, the central bank can avoid choosing one path and risk getting that forecast its related needs of monetary policy, very wrong.

The Bank of Canada will need to be “flexible and adaptable,” Macklem said, in order to react quickly to new developments on the tariff front.

“We need to set policy that minimizes the risk,” he said. “That means being less forward-looking than normal until the situation is clearer. And it may mean acting quickly when things crystallize.”

Macklem’s speech comes days after Statistics Canada reported that inflation jumped up to 2.6 per cent in February, largely thanks to the end of Ottawa’s two-month GST break.

It’s unclear how quickly businesses will pass on the higher costs of tariffs to customers, Macklem noted, so the Bank of Canada has prepared multiple scenarios.

In one possibility, where broad tariffs see costs rapidly passed through over the course of a year, inflation rises roughly 2.25 percentage points higher in the first quarter of 2026 than it would have without the trade war. The Bank of Canada’s January projections had inflation averaging to 2.1 per cent through 2026, before the impact of tariffs.

The example projecting a rapid rise in prices would see the one-time hit to inflation tied to tariffs unwind sooner, however, almost fully fading from the forecast by the end of 2027.

Other scenarios that see a more gradual pass-through of higher prices mean the inflationary hit would never rise as high as in the first case study, but would stay for longer.

Macklem said the Bank of Canada is firm on its commitment to price stability and will use its policy rate to keep inflation – and Canadians’ expectations of inflation – under control.

“We cannot resolve trade uncertainty, but there can be no doubt about our commitment to low inflation. Canadians need to have confidence that we will maintain price stability over time, even during periods of great upheaval,” he said.

This report by The Canadian Press was first published March 20, 2025.