BMO, RBC say interest rates could fall harder and faster with tariffs in play

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Two of Canada’s largest banks say interest rates could fall faster and ultimately end up lower than previously predicted, as the consequences of a trade war with the U.S. are set to ripple through the Canadian economy.

U.S. President Donald Trump’s executive order imposing a 25 per cent tariff on most Canadian imports, with a carveout for energy products that will be taxed at 10 per cent, came into effect as of 12:01 EST Tuesday.

It triggered chaos in global financial markets and caused Bank of Montreal to revise its economic and interest rate forecast, saying it expects at least twice as many interest rate cuts from the Bank of Canada this year compared to previous estimates.

“We now look for the quarter-point pace to continue in each of the next four meetings until July, taking the rate to two per cent,” wrote Douglas Porter, the bank’s chief economist and managing director of economics, in a BMO Economics note published Tuesday.

“The net risk is that we eventually go even lower, if the (Bank of Canada) is comfortable with the prevailing inflation backdrop later this year.”

In the note, Porter called the ongoing trade conflict a “fluid situation.”

“Further adjustments may be required in the weeks ahead, as more information comes to light in terms of Canada’s fiscal response, as well as any potential U.S. countermeasures, or even a possible off-ramp for the tariffs,” he wrote.

“For now, we are incorporating the information on hand, and assuming that the tariffs will be in place for a year.”

In a similar note from Royal Bank of Canada on Tuesday, the lender’s chief economist, Frances Donald, and its assistant chief economist, Cynthia Leach, said that the Bank of Canada has until now been “noncommittal” in how it would react if tariffs were implemented.

“Without tariffs, we expected the BoC to gradually cut rates to 2.25 per cent. Now, we expect that the longer tariffs remain in play, the greater the likelihood that rates fall faster and by a larger magnitude,” they wrote.

The manner in which federal and provincial governments provide fiscal stimulus to offset the negative impacts of a prolonged trade conflict “will also matter” to the central bank, the note said.

“A prolonged trade shock means governments would have to respond to both the immediate recession, while also strengthening the underlying economy that is ill positioned to absorb such a shock,” it said.

“Targeted support would help to offset the growth impact, while broad-based cash transfers risk inflation that would complicate the (Bank of Canada’s) job and limit future fiscal firepower.”

Porter said in his note that while the Bank of Canada’s main focus going forward will be to minimize the negative impacts of an economic slowdown and potential recession, the central bank will still need to keep an eye on inflation.

“There will be a measure of caution in the policy easing, with inflationary pressures simultaneously prodded by retaliatory tariffs and Canadian dollar depreciation,” he said.

The Bank of Canada is set to make its next policy decision on Wednesday, March 12.