Speaking to the Mississauga Board of Trade on Friday, Macklem outlined the stark economic consequences of a prolonged trade conflict, particularly if Canada retaliates with tariffs of its own.

“Increased trade friction with the United States is a new reality,” he said, cautioning that such a shock wouldn’t be temporary—it would fundamentally alter Canada’s economic trajectory.

“The economic consequences of a protracted trade conflict would be severe,” he continued. “If tariffs are long-lasting and broad-based, there won’t be a bounce-back. We may eventually regain our current rate of growth, but the level of output would be permanently lower.”

A weakened economy and higher inflation

Macklem detailed how a significant rise in tariffs would lead to an immediate decline in exports, triggering production cuts and job losses.

“Exports fall by 8.5% in the year after the tariffs take effect,” he noted, based on current Bank models, adding that business investment would also contract by nearly 12% due to higher costs and reduced confidence.

While lower export revenues would curb household income and slow consumer spending, retaliatory tariffs would also drive up prices for many imported goods.

“Roughly 13% of Canada’s CPI basket is made up of goods imported from the United States,” Macklem said, emphasizing that a weaker Canadian dollar would only compound the problem by making all imported goods more expensive.

What this means for interest rates

The Bank of Canada has been steadily cutting rates as inflation recedes, with the policy rate now well below its recent highs. However, Macklem warned that the central bank would have limited ability to shield the economy from a trade shock. While lower rates could help support domestic demand, the BoC would have to tread carefully to avoid stoking inflation.

“Monetary policy can help smooth the adjustment by supporting demand so it doesn’t weaken too much more than supply. But how much support monetary policy can provide is constrained by the need to control inflation,” he said.

“Monetary policy can help smooth the adjustment, but it cannot restore lost supply or fully offset the economic damage,” he said. “The initial impact of tariffs is a one-time rise in the level of consumer prices. Monetary policy cannot change that.”

This presents a challenge for mortgage borrowers. A weaker economy might support further rate cuts, but if inflation remains sticky due to rising import prices, the BoC could be forced to hold rates higher than expected. “Simply put, monetary policy needs to ensure the increase in inflation is temporary,” Macklem said.

A long-term shift in Canada’s economic landscape

Beyond monetary policy, Macklem stressed that Canada needs structural changes to counteract the negative effects of a trade war.

That includes reducing interprovincial trade barriers, improving labour mobility, and investing in better east-west transportation links to expand access to overseas markets.

But while those policy shifts could help in the long run, the immediate outlook remains challenging.

“A protracted trade conflict would sharply reduce exports and investment. It will cost jobs and boost inflation in the next few years and lower our standard of living in the long run,” Macklem said. “The uncertainty alone is already causing harm.”

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Last modified: February 21, 2025