Bank of Canada sees trade war permanently cutting output by 2.5%

By Bloomberg News

February 21, 2025 at 3:52PM EST

While Bank of Canada Governor Tiff Macklem insists there is a limit to the monetary policy response to a tariff war, he is clear about the damage it could cause to the Canadian economy.

“Increased trade friction with the US is a new reality,” he said in a Friday speech in the Toronto area. Though tariffs' timing, degree, and duration are uncertain, the governor said it looks inescapable that “a structural change is upon us.”

Macklem laid out a chain reaction in the event the US were to impose 10% tariffs on energy products and 25% levies on everything else the country buys from Canada, which would also hit back with retaliatory measures on certain products.

All in, a US-Canada tariff war would plunge Canadian output by nearly 3% over two years and “wipe out growth” during that period, Macklem said. While the economy may expand again after the initial shock, the path for long-term growth would be 2.5% lower than a scenario where there were no tariffs.

With levied Canadian goods becoming more expensive in the US, demand for those products would tumble. The bank sees exports falling by 8.5% in the year after the tariffs take effect, and exporters cutting production and laying off workers.

“The shock would be felt across Canada” because exports to the US account for about a quarter of national income, he said.

Lower export revenues would reduce household income, and retaliatory tariffs would temporarily raise consumer prices above the 2% target, both of which would deter consumer spending. The bank expects consumption to decline by more than 2% by mid-2027.

The depreciation of the Canadian dollar would increase the prices of imported goods and services, and integrated supply chains between two countries can add costs at multiple stages of production.

With export and consumer demand weakening, businesses would cut their investment spending. Higher costs and lower profit margins would suppress those expenditures even more. The bank forecasts investment to drop by almost 12% by 2026.

Macklem reiterated that the bank is now “better positioned to contribute to economic stability” with inflation now back at target, and warned there’s a limit to a monetary policy response.

“Unlike the pandemic, if tariffs persist there will be no economic bounce-back,” he said. “Monetary policy cannot restore the lost supply. At most, it can smooth the decline in demand.”

With assistance from Erik Hertzberg.