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The Bank of Canada faces a difficult task: setting monetary policy at a time when inflation has shown signs of stubbornness and the economy picks up steam, while risks of a sharp downturn tied to U.S. tariffs loom on the horizon.

“It’s a very difficult position for the Bank of Canada to be in,� said Randall Bartlett, Desjardins Group deputy chief economist, in an interview.

Even as U.S. President Donald Trump followed through on his promises to impose sweeping tariffs on Canadian goods on March 4, the exact nature of those tariffs have shifted with a series of pauses and amendments in the days since.

"Who knows what this could look like from day-to-day? It’s almost anyone’s guess," Bartlett said. 

There will be harsh consequences for the Canadian economy in the event of a prolonged trade war with the U.S.

Inflation is likely to rise in the near-term from the trade disruptions, Bartlett said, and job losses in hard-hit sectors could quickly pile up if those industries don't receive tariff reprieves. 

Desjardins expects Canada would fall into a recession by mid-year if steep tariffs remain in place.

That's a far cry from the trajectory the Canadian economy had been on heading into 2025.

There were signs late last year that previous interest rate cuts from the Bank of Canada were starting to filter through the economy. A renewed Canadian consumer led to a surge in retail activity to close out 2024 and suggested that, barring a major disruption, 2025 was going to be a year of recovery.

After six consecutive cuts to bring the Bank of Canada's interest rate down to three per cent, Bartlett said the "economic tea leaves" should have been telling the central bank to pause its easing cycle and wait to see where inflation and the economy settled in the coming months.

"But then obviously we got hit with the tariff shock on March 4 and all bets are off in terms of what that means ... for the Bank of Canada," Bartlett said.

Financial markets were largely tilted toward a quarter-point rate cut as of Friday, according to LSEG Data & Analytics. Before tariffs went ahead, markets were showing odds of a hold or cut were essentially a toss-up.

Bank of Canada governor Tiff Macklem said in a speech on Feb. 21 that, if tariffs are broad-based and long-lasting, "there won't be a bounce back" in the Canadian economy as there was during the recovery from the COVID-19 pandemic. It would be a "structural change," he warned.

Macklem went on to explain that the central bank can't lean against both weak growth and rising inflation tied to a tariff shock at the same time. He said the central bank plans to use its policy rate to help "smooth" the impact on the economy while keeping inflation expectations well anchored to the two per cent target.

Andrew Grantham, senior economist with CIBC Capital Markets, said in a note to clients on Friday that the central bank "can't solve the tariff issue" with rate cuts, but it can help the economy transition through the turbulence.

CIBC expects the bank to deliver a quarter-point cut on Wednesday, lowering the benchmark rate to 2.75 per cent, with more cuts to follow this year if trade uncertainty lasts.

Bartlett said he expected the Bank of Canada would err on the side of providing a bit of support to the Canadian economy with a 25-basis-point cut, but hold back from anything larger as it waits to see how long tariffs stay in place in the coming weeks.

He warned the central bank will be constrained in how low it can take its policy rate, in part because of the flagging Canadian dollar.

The loonie is vulnerable not only to hits from the trade war, but also to a widening differential between policy rates in Canada and the U.S., Bartlett said.

If the Bank of Canada drops its policy rate too sharply, the loonie could fall as well, leading to a bigger surge in inflation on food and other goods imported from the U.S.

This report by °µÍø½ûÇø was first published March 10, 2025.