Market News

By Erik Hertzberg

(Bloomberg) -- Markets are starting to price in deeper rate cuts from the Bank of Canada as the economy faces the prospect of a lengthy trade dispute with the U.S. that would likely cause a recession.

Traders in overnight swaps put the odds at more than 20 per cent that the central bank will cut by half a percentage point at its March 12 meeting, as of 2 p.m. Ottawa time Monday. On Jan. 30, markets weren’t even fully pricing a quarter percentage point cut.

Market pricing now implies that many traders are betting the bank will eventually drop its policy rate to around 2.25 per cent. That’s also a change from last week, when markets signaled the rate would go no lower than 2.5 per cent in this cycle.

Analysts and economists are beginning to size up the prospects the central bank would do an emergency cut before the March meeting. That would be a rare move for the central bank — it last did so in March 2020 during the COVID-19 crisis.

At that time, global markets were reeling and economists were forecasting unprecedented economic damage and job losses. This time, the economic damage is likely to be less severe, and the probability of a prolonged trade war is hard to pin down.

“An intermeeting cut would only be appropriate in response to significant financial market stresses, and would likely be accompanied by other measures needed to support markets,” Andrew Kelvin, head of Canadian and global rates strategy at Toronto-Dominion Bank’s securities division, said by email.

Last week, the Bank of Canada cut the benchmark overnight rate by a quarter percentage point to three per cent, and officials dropped any forward-looking guidance about how they plan to adjust borrowing costs in the future, saying the threat of a trade battle made it too uncertain.

Then, on Saturday, U.S. President Donald Trump signed an order to move forward with 25 per cent tariffs on imports of most Canadian goods as of Tuesday, and 10 per cent on energy. Canada announced retaliatory tariffs on U.S. products, though most of them won’t take effect for three weeks — giving some time for the sides to potentially discuss a deal.

Prime Minister Justin Trudeau has said he supports the “principle” of counter-tariffs that are equal in dollar value to the US tariffs. Canada’s announced retaliation plan — covering $155 billion (US$106 billion) of U.S.-made goods — doesn’t go that far, potentially limiting the inflationary pressure of the trade dispute.

Bank of Canada Governor Tiff Macklem said in an interview with Bloomberg last week that monetary policy couldn’t fix the damage of the trade war, but could help to ease the pain of adjustment. He acknowledged that the central bank may opt to update its outlook as more details about the potential dispute come to light.

“We certainly don’t have all the answers, but where we can provide some analysis about what this could mean, I think we should do our best to get it out there,” Macklem said.

It’s possible that federal fiscal measures — borrowing and spending to help the economy — will also be deployed to alleviate the impacts, Toronto-Dominion’s Kelvin said.

“The bank needs to be careful not to overcommit. This is especially true, given that we don’t have any real sense of the scope of potential fiscal supports.”

--With assistance from Laura Dhillon Kane.