CANADA ECONOMICS FEATURE: "Another Quarter Point Cut Next Week Might Be Only Chicken Soup For the Economy's Soul," says CIBC's Shenfeld

According to CIBC's Avery Shenfeld in his latest 'The Week Ahead' column on Friday, Bank of Canada Governor Tiff Macklem "has a point" when saying monetary policy, and its singular instrument, interest rates, "can't be a cure-all" for the trade risks that will ail the economy in the months ahead. "But like chicken soup for a cold," Shenfeld added, "it couldn't hurt either, and might make some corners of the economy feel a little better."

Shenfeld writes: "Make no mistake, the trade war is still very much in play. A one-month reprieve means little, particularly since exporters rushed to get their March shipments across the border ahead of time, leaving less export demand for the coming few weeks.

"Even if the 25% "fentanyl" tariffs are dropped in April, and there's been no guarantee of that, they'll be replaced by "reciprocal tariffs" that could still be quite elevated. The White House will be free to calculate Canada's tariff and non-tariff barriers with the same degree of rigor that they applied in their assessment of Canada's role in US fentanyl supply. American officials repeatedly cite high effective tariffs on dairy, the digital services tax, as well as the GST/HST (which isn't a tariff as its applied equally on imports and domestic products in the Canadian market). The President, and his cabinet, seem particularly determined to shift activity in the auto sector out of Canada and Mexico into the US.

"Had the country not been plunged into a trade war, there would have been ample reasons for the Bank of Canada to at least pause on its rate cutting path. GDP growth not only surprised to the upside in Q4, but revised Q3 readings looked significantly better. Soft February hiring still left a strong average gain over the past three months. Underlying inflation was still tracking at an acceptable level, but there was certainly time to let the data speak for a while to see if more rate cuts were needed.

"That upcoming data might have justified additional rate trimming ahead, if perhaps not the three quarter point cuts we had expected before the GDP surprise, but which we've now retained as our call given the trade uncertainties. We judged the output gap as wider than the BoC's estimates as of mid-2024. The mechanical approach that the Bank applies from quarter to quarter would have dramatically lowered its estimate of that gap to less than 0.5% after the second half GDP burst.

"But the growth in demand was accompanied by a long overdue, cyclical pickup in productivity, implying that potential GDP, the economy's non-inflationary speed limit, has also picked up, leaving considerable elbow room for non-inflationary growth. That's more consistent with the still-elevated readings of labour market slack in February.

"But now, all of that, and even the strong start to some 2025 data as exporters rushed to beat tariffs, is in the rear view mirror. We don't know how long the trade war will last. But it's clear that actions at the border aren't enough, and that the US President is looking at the full trade relationship with its neighbours.

"As a result, without a truce in April, we see Canadian GDP shrinking in Q2 and unemployment rising over the spring to new cyclical highs. Fiscal measures due to be announced shortly could help cushion that blow, but larger programs will likely have to wait until May at the earliest, given the upcoming election.

"Yes, amidst that downturn in the economy, there will be one-off bump in inflation, capturing Canada's own tariffs, and rising production costs stateside due to American tariffs on inputs. But in the context of an economic slowdown, rising unemployment, and reduced household spending power, that's much less likely to spark a sustained wage price spiral. You might pay more for a car, but rents are likely to slump as Canadians' ability to pay takes a hit.

"The Bank's job is to keep an eye further out on the horizon than a month or two. It can't reopen a shuttered factory with a few rate cuts, but it can support domestic demand as an offset. Indeed, the Governor, while noting that a structural hit to the economy isn't something he can magically fix, did say that the Bank can help smooth the adjustment process. With only one tool at his disposal to "help", that suggests that he's on board with some further interest rate relief. Another quarter point cut next week might be only chicken soup for the economy's soul, but as they say, even if it can't help much, it couldn't hurt."