Trump’s trade war threatens Canadian economic gains, Bank of Canada warns

The Bank of Canada is seen in Ottawa, on Wednesday, April 16, 2025. THE CANADIAN PRESS/Justin Tang

The financial picture for Canadian households and businesses was showing signs of increased health until the United States started a trade war, the Bank of Canada said Thursday.

The central bank says in its latest Financial Stability Report that households at the start of the year had, on average, less debt relative to their income than a year earlier, while insolvency filings by businesses had dropped significantly.

However, the U.S.-instigated trade war has pushed risks higher overall, governor Tiff Macklem said.

“The big message in this report is we now face a new threat,” he told a news conference in Ottawa.

“The trade war poses new risks. So even if things were moving in the right direction, it’s a really good time to get prepared for possible turbulence ahead.”

There’s tremendous uncertainty as to the future direction of tariffs, but in a scenario where they’re increased and remain for several years, the Bank of Canada sees the potential for Canadians to fall behind on mortgage payments at levels not seen in a generation.

“A long-lasting trade war poses the greatest threat to the Canadian economy,” Macklem said.

In its more pessimistic scenario, which the central bank emphasized is not a forecast, an extended trade war could cause mortgage arrears to top 0.5 per cent, higher than what happened during the 2008-09 global financial crisis, though still below the more than 0.6 per cent seen in the 1990s.

Government supports could help lessen the impact, but it’s not yet clear how widely or generously those might be doled out.

A stress-test scenario on Canada’s financial system by the International Monetary Fund, included in the bank’s report, used a more extreme scenario. While the Bank of Canada’s own risk scenario sees a recession lasting four quarters, which is roughly in line with the 2008-09 and the 1990-91 recessions, the IMF scenario tests against seven quarters.

Under its scenario, the IMF saw the potential for GDP to fall 5.1 per cent, unemployment to peak at 9.2 per cent, house prices to drop 26 per cent and equities to fall 36 per cent, peak to trough.

While the bank is testing against what could go wrong, Macklem said that recent developments, including news of trade progress between the U.S. and the U.K., shows some easing of tension but that it’s still early days.

And even if the trade risks were immediately lifted, there would still be an overhang, he said.

“I expect there will be some permanent impacts. It does feel like trust has been broken to a certain degree.”

The current disruptions, and the potential for more on the way, are a sharp contrast to how the financial picture was looking at the start of the year.

The Bank of Canada noted that while there has been heightened concerns in recent years about the wave of mortgages coming up for renewal at higher rates, the shock is looking smaller than it did at the end of 2023.

A sharp drop in interest rates in 2024 means payments are not expected to rise as much as feared. Many homeowners have also seen their incomes rise and property values increase.

Non-financial businesses also remain in good financial health, the bank said, noting a spike in insolvencies following the end of government supports was short-lived. It says that until the sharp increase in market volatility at the start of April, the issuance of new debt was also strong and the cost of financing remained low.

While lower interest rates have helped boost the resiliency of businesses and those with mortgages, non-mortgage households do still show rising signs of economic stress.

The report shows that for those households, both credit card and auto loans more than 60 days behind in payments have surpassed pre-pandemic levels, and have risen above historical averages.

That’s in contrast to households with mortgages, where payment arrears on both remain below historical averages.

Canadians overall also still have high debt levels compared with historical standards, creating elevated risks if the trade war persists, especially for those more exposed to tariffs.

The Bank of Canada says loans to households or businesses in trade-sensitive industries or regions represent about 15 per cent of assets of banks in Canada, but that the knock-on effects of an economic slowdown could hit a wider range of industries and workers.

Canadian banks are however well-positioned to absorb higher losses thanks to higher capital buffers and provisions for credit losses, the central bank said.

Macklem said the financial system as a whole remains resilient, but it’s important to keep a close eye on what could go wrong.

“We want to make sure that there is a level of vigilance, that there isn’t overconfidence that everything is going to work out, and that the financial system is prepared for turbulence.”

This report by The Canadian Press was first published May 8, 2025.

By Ian Bickis, The Canadian Press