The Bank of Canada cut the benchmark interest rate a quarter point to three per cent and released an updated outlook that predicts moderate growth through 2026.

However, that forecast is based on a world without tariffs on U.S. imports from Canada, a situation that policymakers concede is unlikely given President Donald Trump’s threats to apply tariffs as soon as the weekend. If broad-based and “significant” border taxes were imposed, the “resilience of Canada’s economy would be tested,” the central bank said in a statement. 

Calm before the storm: The Bank of Canada can’t model a phantom trade war. “The absence of large, broad-based tariffs in the past makes it difficult to quantify with precision how their effects would flow through the economy,” officials wrote in their latest quarterly economic forecast. 

Based on what it knows today, the economy is in OK shape. Inflation is back at the target of two per cent. Gross domestic product is forecast to grow 1.8 per cent this year and next—better than 1.3 per cent in 2024 and somewhat faster than the central bank’s estimate of how fast the economy can expand without triggering inflation. “Lower interest rates are boosting household spending, and economic activity is picking up,” governor Tiff Macklem said in a statement.

The Bank of Canada also signalled a return to normal by announcing that it intends to resume purchasing assets like it did before the COVID-19 crisis. It had been staying out of the market because its balance sheet ballooned during the pandemic, as it purchased assets to keep borrowing costs low. The central bank said its portfolio has now shrunk enough that it can resume normal operations.  

State of readiness: The economy that the Bank of Canada describes in its monetary policy report isn’t strong. That’s why policymakers cut borrowing costs again, dropping the policy rate to three per cent. The new baseline prediction for growth is lower than the previous forecast, mostly because the federal government’s immigration cuts will slow population growth. The central bank called business investment “weak” and the labour market “soft.” It’s a trajectory that would let Macklem declare victory in his fight against inflation, as he would have wrestled runaway prices back to normal without causing a recession. The problem is that Canada’s short-term prospects have rarely been less certain. 

Heavy weather: The central bank offered no hint on where interest rates could be headed in March, when officials next gather to set rates. That will depend on the size and breadth of tariffs, the extent to which Canada retaliates and how businesses and consumers respond to both. Projections are subject to “more-than-usual uncertainty,” the central bank said. 

To show why that’s so, officials published a scenario analysis of what could happen if Trump imposed a tariff of 25 per cent on all goods imports, and U.S. trading partners retaliated in kind. Governments use half the revenue they collect from border taxes to increase transfers to households, and they use the rest to pay down debt.

The central bank ran several variations through its models based on how tariffs might ripple through the economy. Bottom line: Economic growth slows and inflation accelerates in every circumstance. That would put the central bank in a jam, because the interest rate ultimately can attack only one of those problems at a time. 

“We can’t lean against weaker output and higher inflation at the same time,” Macklem said. “As we consider our monetary response, we will need to carefully assess the downward pressure on inflation from weakness in the economy, and weigh that against the upward pressure on inflation from higher input prices and supply chain disruptions.” 

Keep your eye on the skies.