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In response to the recent initiation of a trade war between Canada and the United States, BMO Capital Markets anticipates significant economic repercussions for Canada. The U.S. has imposed a 25% tariff on all Canadian goods, excluding energy products, which face a 10% tariff. Canada has retaliated with a 25% tariff on $155 billion worth of U.S. imports, with $30 billion of these tariffs taking effect immediately and the remainder in 21 days. BMO projects that these measures will increase Canada's Consumer Price Index (CPI) by nearly one percentage point this year and raise the unemployment rate to 8%, an increase of one percentage point from prior forecasts.

Given these developments, BMO now expects the Bank of Canada (BoC) to implement more aggressive interest rate cuts to stimulate the economy. Previously, BMO anticipated two additional rate cuts this year, bringing the overnight rate to 2.50%. However, the bank now forecasts a 25 basis point cut at each BoC meeting until October, resulting in a terminal rate of 1.50%. This trajectory would push the Canada-U.S. overnight rate spread beyond -225 basis points, approaching historic lows last seen in 1997.

It's important to note that Canada's CPI calculation method differs from that of other countries, as it excludes borrowing costs. This approach means that rate cuts can immediately lower reported inflation without necessarily affecting the actual prices of goods and services. Consequently, Canadian policymakers may respond differently to economic shocks compared to their international counterparts. As Canadian and U.S. leaders are scheduled to meet soon, any agreements reached could alter the current economic outlook.

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