Trump has imposed tariffs of 25% on goods coming from Mexico and Canada, 10% on Canadian energy, and 10% on goods from China. He justified these actions by claiming they would force Mexico and Canada to address issues related to undocumented migration and drug trafficking. However, while precursor chemicals for fentanyl come from China and undocumented migrants enter through the southern border with Mexico, Canada accounts for only about 1% of both issues.

The affected countries are preparing their responses. Canada has launched a crisis plan reminiscent of its response to the COVID-19 pandemic, while Mexican President Claudia Sheinbaum has developed a “Plan B” to protect her country. In contrast, China’s response has been more subdued. It pledged to implement “corresponding countermeasures” without providing further details.

The Wall Street Journal, typically considered a conservative publication, criticized Trump, labelling this as the “dumbest trade war in history.” The Journal stated, “Mr. Trump sometimes sounds as if the U.S. shouldn’t import anything at all, that America can be a perfectly closed economy making everything at home. This is called autarky, and it isn’t the world we live in or one that we should want to live in, as Mr. Trump may soon find out.”

Trump inherited a strong economy from his predecessor, President Joe Biden. However, as White House Press Secretary Karoline Leavitt confirmed Trump’s decision to levy the tariffs on Friday, the stock market plunged. Trump, who previously insisted that tariffs would boost the economy, acknowledged today that Americans might experience “SOME PAIN” due to the tariffs. He added, “BUT WE WILL MAKE AMERICA GREAT AGAIN, AND IT WILL ALL BE WORTH THE PRICE THAT MUST BE PAID.”

Trump has admired tariffs and often praises President McKinley for his extensive tariff impositions. After 450 amendments, the Tariff Act of 1890 raised average import duties from 38% to 49.5%. McKinley, known as the “Napoleon of Protection,” increased rates on some goods while lowering them on others, always aiming to protect American manufacturing interests. His presidency saw rapid economic growth, bolstered by the 1897 Dingley Tariff, which aimed to shield manufacturers and factory workers from foreign competition.

While Trump claims the McKinley tariffs made the U.S. a global economic leader, other factors contributed to this outcome. During the late 19th century, U.S. immigration surged, and American entrepreneurs learned from Britain’s best practices, which was then the world leader in technological advancement.

Consider the U.S. auto industry, which operates as a North American entity due to the highly integrated supply chains across the three countries. In 2024, Canada supplied nearly 13% of U.S. auto parts imports, while Mexico accounted for almost 42%. Industry experts note that a vehicle produced on the continent typically crosses borders multiple times as companies source components and add value most cost-effectively.

This integration benefits everyone involved. According to the Office of the U.S. Trade Representative, the industry contributed more than $809 billion to the U.S. economy in 2023, representing about 11.2% of total U.S. manufacturing output and supporting 9.7 million direct and indirect U.S. jobs. In 2022, the U.S. exported $75.4 billion in vehicles and parts to Canada and Mexico. According to the American Automotive Policy Council, this figure rose by 14% in 2023, reaching $86.2 billion.

Without this trade, American car makers would struggle to compete. Regional integration has become an industry-wide manufacturing strategy in Japan, Korea, and Europe. It aims to leverage high-skilled and low-cost labour markets to source components, software, and assembly.

As a result, U.S. industrial capacity in automobiles has grown alongside an increase in imported motor vehicles, engines, and parts. From 1995 to 2019, imports of these items rose by 169%, while U.S. industrial capacity in the same categories increased by 71%. Thousands of well-paying auto jobs in states like Texas, Ohio, Illinois, and Michigan owe their competitiveness to this ecosystem, which relies heavily on suppliers in Mexico and Canada.

Tariffs will also disrupt the cross-border trade of agricultural products. In fiscal 2024, Mexican food exports represented about 23% of U.S. agricultural imports, while Canada supplied approximately 20%. Many leading U.S. growers have relocated to Mexico because of regulatory limits and economic advantages. Unless a last-minute deal is reached during Trump’s calls with the leaders of Canada and Mexico today. The European Union is next on its list for potential tariffs, and the EU has promised to “respond firmly” if this occurs.

Trump slapped tariffs of 25% on goods from Mexico and Canada, 10% on Canadian energy, and 10% on goods from China. He said he was doing so to force Mexico and Canada to do more about undocumented migration and drug trafficking. Still, while precursor chemicals to make fentanyl come from China and undocumented migrants come over the southern border with Mexico, Canada accounts for only about 1% of both.

The countries affected by the tariffs are also preparing their defences. Canada has launched a crisis response that parallels the COVID pandemic, while Mexican President Claudia Sheinbaum has developed a “Plan B” to protect her country. China’s reaction was more subdued. They pledged to implement “corresponding countermeasures,” though they did not provide further details.

The Wall Street Journal, hardly a bastion of progressive thought, lambasted Trump, saying this is the “dumbest trade war in history.” The Journal said, “Mr. Trump sometimes sounds as if the U.S. shouldn’t import anything at all, that America can be a perfectly closed economy making everything at home. This is called autarky, and it isn’t the world we live in or one that we should want to live in, as Mr. Trump may soon find out.”

Trump inherited the best economy in the world from his predecessor, President Joe Biden. However, on Friday, as soon as White House press secretary Karoline Leavitt confirmed that Trump would levy the tariffs, the stock market plunged. Trump, who during his campaign insisted that tariffs would boost the economy, said that Americans could feel “SOME PAIN” from them. He added, “BUT WE WILL MAKE AMERICA GREAT AGAIN, AND IT WILL ALL BE WORTH THE PRICE THAT MUST BE PAID.”

Trump loves tariffs and lauds President McKinley for his massive tariff imposition. After 450 amendments, the Tariff Act of 1890 increased average duties across all imports from 38% to 49.5%. McKinley was known as the “Napoleon of Protection,” and rates were raised on some goods and lowered on others, always trying to protect American manufacturing interests. McKinley’s presidency saw rapid economic growth. He promoted the 1897 Dingley Tariff to protect manufacturers and factory workers from foreign competition, and in 1900, secured the passage of the Gold Standard Act.

President Trump has said the McKinley tariffs made the US a global economic leader, but much else was responsible. Over the late 19th century, US immigration increased sharply. American entrepreneurs put a great store in the best practices of Britain, then the global leader in technological development.

The U.S. auto industry is  North American because supply chains in the three countries are highly integrated. In 2024, Canada supplied almost 13% of U.S. auto parts imports, and Mexico provided nearly 42%. Industry experts say a vehicle made on the continent crosses borders a half-dozen times or more as companies source components and add value in the most cost-effective ways.

Everyone benefits. The Office of the U.S. Trade Representative says that 2023 the industry added more than $809 billion to the U.S. economy, or about 11.2% of total U.S. manufacturing output, supporting “9.7 million direct and indirect U.S. jobs.” In 2022, the U.S. exported $75.4 billion in vehicles and parts to Canada and Mexico. According to the American Automotive Policy Council, that number jumped 14% in 2023 to $86.2 billion.

American car makers would be much less competitive without this trade. Regional integration is now an industry-wide manufacturing strategy employed in Japan, Korea, and Europe that aims to source components, software, and assembly from various high-skilled and low-cost labour markets.

The result has been that U.S. industrial capacity in autos has grown alongside an increase in imported motor vehicles, engines, and parts. From 1995 to 2019, imports of automobiles, engines, and parts rose 169%, while U.S. industrial capacity in cars, engines, and parts rose 71%. Thousands of good-paying auto jobs in Texas, Ohio, Illinois, and Michigan owe their competitiveness to this ecosystem, which relies heavily on suppliers in Mexico and Canada.

Tariffs will also cause mayhem in the cross-border trade of farm goods. In fiscal 2024, Mexican food exports comprised about 23% of U.S. agricultural imports, while Canada supplied some 20%. Many top U.S. growers have moved to Mexico because limits on legal immigration have made it hard to find workers in the U.S. Mexico now supplies 90% of avocados sold in the U.S.

Canadian Prime Minister Justin Trudeau has promised to respond to U.S. tariffs on a dollar-for-dollar basis. Since Canada’s economy is so small, this could result in a larger GDP hit, but American consumers will feel the bite of higher costs for some goods.

None of this is supposed to happen under the U.S.-Mexico-Canada trade agreement that Mr. Trump negotiated and signed in his first term. The U.S. willingness to ignore its treaty obligations, even with friends, won’t make other countries eager to do deals. Maybe Mr. Trump will claim victory and pull back if he wins some token concessions. But if a North American trade war persists, it will qualify as one of the dumbest in history.

Bottom Line

This is a lose-lose situation. Prices will rise in all three continental countries if the tariffs persist. While inflation is the first effect, we will quickly see layoffs in the auto sector and elsewhere. Ultimately, the Bank of Canada would be confronted with a recession and will ease monetary policy in response. Interest rates would fall considerably. The Canada 5-year government bond yield has fallen precipitously, down to 2.59%. In this regard, housing activity would pick up, similar to what we saw in 2021, with weak economic activity but booming housing in response to low mortgage rates.

I am still hopeful that an all-out trade war can be averted. There is room to negotiate. As stated by Rob McLister, “Trump underestimates the global revolt against this move, and that’s another reason why these tariffs may be measured in months, not years.” This will not be good for the US. Trump promised to reduce prices, yet sustained tariffs will undoubtedly cause prices to rise. Some of that increase will be absorbed by American importers and some by Canadian exporters anxious to maintain market share. Still, much of the tariff will be passed on to the American consumer in time. This, combined with a North American economic slowdown, will no doubt damage Mr. Trumps approval rating.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres
drsherrycooper@dominionlending.ca

The president had previously pledged to impose tariffs of 10 percent on global imports, 60 percent on Chinese goods, and a 25 percent surcharge on Canadian and Mexican products. Such tariffs would likely disrupt trade flows, increase costs and prices, slow economic activity and provoke retaliatory measures.

An official stated that Trump will instruct agencies to investigate persistent trade deficits and address unfair trade and currency practices by other nations, both of which have been longstanding concerns for him. The presidential memo specifically targets China, Canada, and Mexico, urging agencies to assess Beijing’s compliance with its 2020 trade deal with the US and the status of the U.S.-Mexico-Canada Agreement (USMCA), set for review in 2026.

While the memo does not impose new tariffs, it offers temporary relief for Ottawa and other foreign capitals bracing for immediate, stiff levies from Trump. Instead, the trade policy memo suggests that the incoming administration debate how to fulfill Trump’s campaign promises of widespread tariffs on imports and increased duties for adversaries, particularly China.

A senior policy adviser characterized the memo as an attempt to present a vision for Trump’s trade agenda “in a measured manner,” suggesting that the incoming president is currently adopting a more considerate strategy regarding the topic that fueled his political campaign. The adviser explained that the memo is a framework for potential executive actions that Trump might pursue on trade.

This memo is among several executive actions Trump is expected to sign once he takes office. According to sources familiar with his plans, these actions include declaring a national emergency at the U.S.-Mexico border, rescinding directives from the Biden administration on diversity, equity, and inclusion, and rolling back President Biden’s restrictions on offshore drilling and drilling on federal land.

For weeks, some of Trump’s more traditional economic advisers, such as Treasury Secretary nominee Scott Bessent, have argued that tariffs should not be universally applied—suggesting possible exemptions for specific sectors or gradual implementation of duties. More protectionist advisers, like incoming deputy chief of staff for policy Stephen Miller, have urged Trump to adopt a more aggressive stance by declaring a national emergency, granting him broad authority to raise tariffs significantly. There are ongoing discussions about which sections of US trade law to utilize in addition to a potential emergency declaration.

The memo also alerts Canada and Mexico ahead of the 2026 scheduled review of the updated NAFTA deal signed in 2020. For months, Trump has expressed his intent to renegotiate that deal, seeking assurances from his continental neighbours that they will limit China’s involvement in their economies, especially in critical sectors such as automobiles. The memo’s summary states that federal agencies will “now assess the impact of the USMCA on American workers and businesses and make recommendations regarding America’s participation in it.”

Canadian Sectors Most Vulnerable to Tariffs

The economists at Desjardin recently issued a detailed analysis of the sectors most likely to suffer US tariffs. They conclude that the energy and automotive sectors will likely be exempted from tariffs because no alternative sources can meet US demand. The sectors most likely affected by tariffs are primary metals (including aluminum), food and beverage manufacturing, chemicals, machinery, and aerospace. The transportation and wholesale trade sectors would suffer significant indirect effects from potential tariffs, as would agriculture, fishing and forestry. Industries less exposed to trade should fare better, including many service sectors. However, they could still experience ripple effects of any tariff-induced economic slowdown.

Over 70% of Canada’s goods and services are sold to the United States. Desjardins predicts that Trump will fulfill his promise, but likely with “multiple exceptions.”

The US Energy Information Administration identifies Canada as its top petroleum supplier, followed by Mexico, Saudi Arabia, Iraq, and Colombia. Canada represents nearly 60% of oil imports. Imposing a tax on oil imports would likely raise energy costs in the US, contradicting Trump’s promise to lower energy prices.

The highly integrated automobile sector is another area where the threat of tariffs could create significant issues. The North American auto industry is so interconnected that the tariff would ultimately hurt American manufacturers. Half of the General Motors pickup trucks sold in the US come from Canada or Mexico.

A more targeted approach to tariffs could well emerge. This would align with the experience that Canadian exporters had during Trump’s first presidential term when temporary tariffs were imposed on aluminum, iron, and steel before the Canada-United States-Mexico Agreement (CUSMA) was established.

Currently, US importers are preparing for these potential changes by stocking up on Canadian and other international goods. This trend is expected to continue into the first quarter, as both importers and exporters in Canada and the US await updates from Washington and Ottawa.

Highly Negative Impact

Implementing the tariffs would negatively impact primary metals, food and beverage, chemicals, machinery, aerospace, and parts sectors.

Manufacturers and those in the raw materials sector will require close monitoring. About half of the value of Canadian domestic production in the mining, oil, and gas industry is exported to the US This figure is approximately one-third of the manufacturing sector. Still, it exceeds 50% for the automotive industry and is over 40% in aerospace.

Several other sectors are also identified as “to watch.” These include pulp and paper products, wood products, plastics and rubber products, crop and animal production, fabricated metal products, mining and quarrying, non-metallic mineral products, fishing, hunting and trapping, transportation and warehousing, wholesale trade, forestry and logging, and petroleum and coal products.

Additionally, there is potential for a ripple effect that could impact transportation and warehousing, wholesale trade, and professional services. 

If some of these multinational companies have the option to invest in increasing production in Canada or in their US facilities, it becomes easier for them to decide they’re going to downgrade in Canada because that would mean importing from Canada afterward and incurring extra costs. The risk of reduced investment in Canada is quite real.

63% of Canadian exports to the US are intermediate inputs, while 21% are finished goods. This US dependence on imported inputs is particularly pronounced in three industries: automotive manufacturing, petroleum product manufacturing (made from crude oil, mainly from Canada), and primary metals, which depend on imported mined ores. Even industries such as air transportation and construction depend to a considerable extent on imported inputs (fuel, metal and lumber).

When we look at direct imports and intermediate inputs together, we see that a significant share of US domestic supply and production is dependent on imports, particularly the automotive sector, computers and electronics, electrical appliances, apparel, industrial machinery and primary metals. However, the US’s lower import dependence on certain products makes them more vulnerable to tariffs. These products include wood and paper products, nonmetallic mineral products (with some exceptions, including potash), nonautomotive transportation equipment (including aerospace), and agriculture and agrifood products.

Fortunately for Canada, it would be more difficult for the US to find alternatives for aluminum, pulp and paper, grains and oilseeds, and bakery products, as nearly half of these imports come from Canada. Other sectors are between, with about 30% to 35% of imports from Canada and Mexico. This is the case for iron and steel products, nonferrous metals (excluding aluminum), plastic products and synthetic resins. The aerospace sector is relatively vulnerable, given the availability of European and Asian alternatives. The dynamics in each industry would shift if the US applies tariffs to other supplier countries as well.

Several key products imported from Canada include uranium ore, potash, cobalt, and graphite.

Uranium ore is expected to be exempt from tariffs. Nearly all US demand is met by imports, with Canada supplying 27%. All Canadian uranium mining occurs in Saskatchewan.

Potash, crucial for fertilizers used in agriculture, may also be exempt since it is not mined in the US and alternatives are limited. Canada is the largest potash producer, accounting for 33% of global production, all from Saskatchewan.

Cobalt and graphite are essential for lithium-ion batteries and electronic equipment. China produces 77% of graphite globally, while the Democratic Republic of Congo provides 74% of cobalt. Cobalt mining in Canada is primarily in Ontario and graphite mining in Quebec. The US Department of Defense has invested in Canadian projects to secure these metals, likely leading to tariff exemptions for Canada (Bloomberg, 2024).

Canada’s Response to US Tariffs

The selection of goods for Canada to target is strategic and aimed at creating a political impact. Canadian officials plan to focus on products made in Republican or swing states, where the implications of tariffs—such as job losses and the financial strain on local businesses—could directly affect Trump supporters. The hope is that these allies, including governors and members of Congress, will reach out to Trump to advocate for de-escalation.

Prime Minister Justin Trudeau and his cabinet will convene on Monday and Tuesday in what is being referred to as their “U.S. war room” to respond swiftly if US tariffs are announced. While the detailed list of targeted goods is confidential, it should include various consumer items, including food and beverages, as well as everyday products like dishwashers and porcelain fixtures such as bathtubs and toilets.

Depending on which Canadian goods Trump decides to impose tariffs on and their specific levels, Canada’s second move would be to broaden its tariffs to include additional American products, affecting imports worth 150 billion Canadian dollars from the US. The Canadian government is considering other measures to restrict the export of goods to the United States. This could involve implementing export quotas or imposing duties that American importers would have to bear, particularly for sensitive Canadian exports that the US relies on—such as hydroelectric power from Quebec that is used to supply energy across New England.

Given the relatively abundant domestic production, negotiating exemptions would be more difficult for products that the US does not significantly rely on for imports. This applies to wood products (notably, Canadian softwood lumber is already subject to a countervailing duty of 14.54%), transportation equipment other than automobiles, paper and cardboard products, agrifood items, and petroleum-based products. For these categories, less than 15% of the US supply is sourced from direct imports.

In contrast, imposing a tariff on motor vehicles and parts is less likely since 35% of the supply in the US domestic market consists of direct imports, with 14% coming from Canada and 38% from Mexico. The same pattern holds for industrial machinery and crude oil, which account for 34% and 31% of imports, respectively.

Tariffs are taxes on goods, which are typically passed on to consumers. This makes imported goods more expensive, often leading consumers to stop buying them and ultimately harming the foreign companies that export them. Trade restrictions, such as export quotas, aim to limit the availability of exported goods. They tend to be particularly effective when the importing country lacks accessible or sufficient alternative sources for those goods.

No matter how Canada implements its counter-tariffs or export restrictions, the main goal will be to pressure the Trump administration to retract its commitment to initiating a damaging trade war with its neighbour.

Canada and the United States have a substantial trading relationship, with nearly $1 trillion worth of goods exchanged annually. Canada frequently alternates positions with Mexico as the US’s largest trading partner, largely depending on oil prices.

Certain cross-border industries are deeply interconnected, making tariffs a difficult regulatory barrier for many companies. For instance, a single vehicle can cross the U.S.-Canadian border up to eight times before fully assembled. Implementing tariffs would disrupt auto assembly operations in the United States and Ontario, the center of Canada’s automotive sector.

Canada exports critical resources to the United States, with around 80 percent of its oil and 60 percent of its natural gas heading south of the border. More than half of the oil imported by the US comes from Canada. If the trade conflict escalates significantly, the Canadian government is prepared with additional measures to respond.

This potential third level of escalation in a trade war, which the Canadian government aims to avoid, could involve restricting the export of sensitive commodities valued at hundreds of billions of dollars. These commodities include oil, gas, potash, uranium, and critical minerals—exports vital to the US.

Alberta, known as Canada’s oil-exporting powerhouse, has opposed any measures that would negatively impact its key industry. The divide between the province’s leadership and the rest of Canada could widen if Canada uses oil as leverage against the United States.

Furthermore, a senior official noted that the Canadian government is preparing for a potentially prolonged trade war with the US by supporting domestic industries. The government is considering financial assistance for Canadian businesses severely affected by US tariffs, likely on a case-by-case basis. While large-scale bailouts or blanket funding for entire industries may not be feasible, the official emphasized that it would be unacceptable for a tariff war with the US to result in the loss of thousands of jobs and businesses without government intervention to mitigate the impact.

Economic Impact on Canada of Tariffs and Other Trade Restrictions

Canada and Mexico are much more dependent on trade than the US. Mexico, in particular, produces many manufactured products headed for the US.

However, there are reasons to believe that Trump will not carry out his threats. During his 2016 presidential campaign, Trump repeatedly threatened to impose a 30 percent tariff on Mexico. Once in office, however, he did not impose the tariff but demanded—and received—a renegotiation of the North American Free Trade Agreement (NAFTA). The renegotiation produced a new agreement with a new name—the US-Mexico-Canada Agreement (USMCA)—which modernized the agreement also by tightening rules of origin and lengthening schedules for tariff removal, moving the agreement away from free trade, and earning the new agreement the mocking sobriquet NAFTA 0.7.

Subsequently, in 2019, Trump threatened Mexico with a 5 percent tariff that would gradually increase to 25 percent unless Mexico stopped illegal immigration across the border, but he did not follow through.

USMCA is scheduled for review in 2026, but if the review is expedited to 2025, the tariffs could be avoided by making concessions in the agreement to placate the Americans. If Trump were to impose those tariffs, he would be blowing up (albeit for noneconomic reasons) the contract that his first administration negotiated. Indeed, a telephone call on November 27 with Mexican president Claudia Sheinbaum, which Trump characterized as a “very productive conversation,” seemed to lower the heat. However, Trump’s public musings about using economic coercion to make Canada the “51st state” contributed to Canadian Prime Minister Justin Trudeau’s resignation, and the upheaval in Canadian politics may make resolution via USMCA more difficult.

Tariffs raise prices and reduce economic activity. Businesses that are heavily impacted often respond by cutting jobs, which further slows economic growth. The negative effects can financially strain local businesses and discourage corporate investment in machinery, facilities, and equipment. While it’s unlikely, higher prices could prompt the central bank to temporarily reverse its easing policies. The Bank of Canada understands that the price effects are temporary, but the slowdown in economic activity poses a more significant and lasting problem.

Bottom Line 

The postponement of tariffs suggests that key advisors to Trump are aware of the potential negative impacts that Canadian and Mexican tariffs would have on the U.S. Canada’s agreement to strengthen its border with the US could lead to a temporary reprieve. Mexico faces a bigger challenge than Canada due to its more porous border. It is encouraging that the new US president has started to backtrack on a commitment he made repeatedly before his inauguration. While it remains uncertain whether tariffs are completely off the table or simply postponed, this situation provides us with time to further strengthen our border and address our financial commitments to NATO—two issues that are priorities for Trump.

If tariffs are eventually imposed, which I doubt, we will see a slowdown in economic activity, rising unemployment, and uncertainty that will likely hinder the robust housing market we anticipate this Spring. The new administration’s more measured approach to its trade agenda is certainly positive news. It is likely that the Canada, US, and Mexico trade deal will once again be renegotiated.

The policy rate is now at the top of the estimated neutral rate range, 2.25% to 3.25%, with more moderate rate cuts continuing into next year. However, monetary policy remains restrictive, as the 3.25% policy rate is still 125 basis points above inflation, which has declined to roughly 2%, the Bank’s inflation target.

Economists have suggested that the tone of the central bank’s press release is more hawkish than before, unsurprising following two consecutive jumbo rate cuts. The Bank continues to say that its future decisions are data-dependent and will be impacted by policy measures taken by the government. In particular, the Bank highlighted the coming GST cuts, dispersal of bonus checks and the significant reduction in immigration. These developments have offsetting implications for inflation.

Governor Macklem signalled that he anticipated “a more gradual approach to monetary policy” in his press conference. We are forecasting 25 bp rate cuts through at least the first half of next year. That would take the overnight rate down to 2.5% by early June, a huge boost to housing that will likely enjoy a strong spring season.

Home sales recorded over Canadian MLS® Systems climbed 1.9% month-over-month in September 2024, reaching their highest level since July 2023. The Greater Toronto Area, Hamilton-Burlington, Montreal and Quebec City, Greater Vancouver and Victoria led the national increase.

“Sales gains are now three for three in the months following interest rate cuts, which is a trend even though the increases weren’t headline-grabbing,” said Shaun Cathcart, CREA’s Senior Economist. “That said, with the pace of rate cuts now expected to be much faster than previously thought, it’s possible some buyers may choose to hold off on a purchase for now. This could further boost the rebound expected in 2025 at the expense of the last few months of this year”.

Overall, the economy’s weakness continues to pull inflation down. However, price pressures in shelter and some other services are holding inflation up. Since the July Monetary Policy Report, the upward forces from prices for shelter and some other services have eased slightly. At the same time, the downward pressure from excess supply in the economy remains.

Tiff Macklem said today, “If inflation continues to ease broadly in line with the central bank’s July forecast, it is reasonable to expect further cuts in the policy rate. We will continue to assess the opposing forces on inflation and take our monetary policy decisions one at a time.”

The economy grew by 2.1% in the second quarter, led by government spending and business investment. This was slightly stronger than forecast in July. Together with the first quarter’s growth of 1.8%, the economy grew by about 2% over the first half of 2024. That’s a healthy rebound from our near-zero growth in the second half of 2023. The Bank’s July projection has growth strengthening further in the second half of this year. Recent indicators suggest there is some downside risk to this pickup. In particular, preliminary indicators suggest that economic activity was soft through June and July, and employment growth has stalled in recent months.

That makes this Friday’s Labour Force Survey data for August particularly important. We expect economic activity to slow in the third quarter to rough 1.3%, keeping the Bank in an easing posture through next year.

The unemployment rate has risen over the last year to 6.4% in June and July. The rise is concentrated in youth and newcomers to Canada, who find it more challenging to get a job. Business layoffs remain moderate, but hiring has been weak. The slack in the labour market is expected to slow wage growth, which remains elevated relative to productivity.

Turning to price pressures, CPI inflation eased further to 2.5% in July, and the central bank’s preferred measures of core inflation also moved lower. With the share of CPI components growing above 3% around its historical norm, there is little evidence of broad-based price pressures. But shelter price inflation is still too high. Despite some early signs of easing, it remains the most significant contributor to overall inflation. Inflation remains elevated in some other services but has declined sharply in manufacturing and goods prices.

As outlined in the Bank of Canada’s Monetary Policy Report, inflation is expected to ease further in the months ahead. It may bump up later in the year as base-year effects unwind, and there is a risk that the upward forces on inflation could be more potent than expected. At the same time, with inflation getting closer to the target, the central bank must increasingly guard against the risk that the economy is too weak and inflation falls too much. Judging from comments made at today’s press conference, the BoC is at least as concerned about too much disinflation–taking the economy into a deflationary spiral.

Macklem said, “We are determined to bring inflation down to the 2% target and keep it there. We care as much about inflation being below the target as we do about it being above it. The economy functions well when inflation is around 2%.”

With continued easing in broad inflationary pressures, the Governing Council reduced the policy interest rate by 25 basis points. Excess supply in the economy continues to put downward pressure on inflation, while price increases in shelter and some other services are holding inflation up. The Governing Council is carefully assessing these opposing forces on inflation. “Monetary policy decisions will be guided by incoming information and our assessment of their implications for the inflation outlook. The Bank remains resolute in its commitment to restoring price stability for Canadians”.

Monthly changes in sales activity were generally small amongst the larger centres in July. Interestingly, declines in Calgary and the Greater Toronto Area were offset mainly by gains in Edmonton and Hamilton-Burlington.

The Consumer Price Index (CPI) rose 2.7% year over year in June, down from a 2.9% gain in May. The deceleration was mainly due to slower year-over-year growth in gasoline prices, which rose 0.4% in June following a 5.6% increase in May. Excluding gasoline, the CPI rose 2.8% in June.

Lower prices for durable goods (-1.8%) y/y also contributed to the slowdown in the all-items CPI in June, following a 0.8% decline in May. An increase in prices for food purchased from stores (+2.1%) moderated the deceleration, as well as a smaller decline for cellular services in June (-12.8%) compared with May (-19.4%).

A Collective Sigh of Relief As The BoC Cut Rates For the First Time in 27 Months

With continued evidence that underlying inflation is easing, the Governing Council agreed that monetary policy no longer needs to be as restrictive. Recent data has increased our confidence that inflation will continue to move towards the 2% target. Nonetheless, risks to the inflation outlook remain. “Governing Council is closely watching the evolution of core inflation and remains particularly focused on the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour.”

As shown in the second chart below, the nominal overnight rate remains 215 basis points above the current median CPI inflation rate, which shows how restrictive monetary policy remains. The average of this measure of real (inflation-adjusted) interest rates in the past 30 years is just 60 bps. The overnight rate is headed for 3.0% by the end of next year.

Bottom Line

There are four more policy decision meetings before the end of this year. It wouldn’t surprise me to see at least three more quarter-point rate cuts this year. While the overnight rate is likely headed for 3.0%, it will remain well above the pre-COVID overnight rate of 1.75% as inflation trends towards 2%+ rather than the sub-2% average in the decade before COVID-19.

Home sales activity recorded over Canadian MLS® Systems fell 1.7% between March and April 2024, a little below the average of the last ten years.

New Listings

The number of newly listed properties rose 2.8% month-over-month.

Slower sales amid more new listings resulted in a 6.5% jump in the overall number of properties on the market, reaching its highest level just before the onset of the COVID-19 pandemic. It was also one of the largest month-over-month gains, second only to those seen during the sharp market slowdown of early 2022.

“April 2023 was characterized by a surge of buyers re-entering a market with new listings at 20-year lows, whereas this spring thus far has been the opposite, with a healthier number of properties to choose from but less enthusiasm on the demand side,” said Shaun Cathcart, CREA’s Senior Economist.

The Bank also noted that Q4 GDP growth came in stronger than expected at 1.0% but was well below potential growth, confirming excess supply in the economy.

Employment continues to rise more slowly than population growth. During the press conference, Governor Macklem said it was too early to consider lowering rates as more time is needed to ensure inflation falls towards the 2% target.