Tariff Talk, and Could Interest Rates Go Up Again?

Will interest rates go up or down in the year ahead? With Canada facing a tariff threat from the United States, financial institutions have been adjusting their monetary policy expectations for the year ahead. One big bank is urging the Bank of Canada to take emergency action.

On Monday, Trump signed executive orders to impose the 25-per-cent tariff on all steel and aluminum imports into the U.S. starting March 12. He also threatened to impose a 25-per-cent tariff on all Canadian imports including lumber, while energy will be subject to a 10-per-cent tariff, starting March 4.

The countdown is on. Meantime, much like the president’s first term, Canada’s financial markets are enduring a case of will-he-or-won’t-he on trade, causing a volatile climate.

At the January policy meeting, the Bank of Canada cut interest rates for the sixth consecutive meeting, lowering the benchmark rate to three per cent.

Central bank chief Tiff Macklem outlined the “economic consequences” of a lingering trade spat, noting that monetary policy can do little to offset the possible fallout.

“The reality is the economy is going to work less efficiently. Canada’s going to produce less. It’s going to earn less. Monetary policy can’t change that,” Macklem told reporters.

That said, the Bank of Canada cut rates to offer a tepid economic cushion from the blows of tariffs.

“With inflation back around the two-per-cent target, we are better positioned to be a source of economic stability,” he added. “However, with a single instrument — our policy interest rate — we can’t lean against weaker output and higher inflation at the same time.”

Canadian Prime Minister Justin Trudeau and his Liberal government informed the public that Ottawa was prepared for retaliatory tariffs. However, after striking an 11^th-hour agreement, the response was unnecessary, and a trade war was delayed for 30 days – until March 4. The prime minister committed to imposing his $1.3 billion plan outlined in December, as well as fresh promises like appointing a fentanyl czar and listing cartels as terrorists.

As for monetary policy, economists think the central bank can do more.

However, National Bank of Canada economists say that there is a solid case for the Bank of Canada to implement emergency rate cuts totalling 100 basis points, bringing the policy rate to 2.25 per cent by the spring.

“While not in recession, Canada’s GDP growth has been below potential for some time, and thus, we’ll need a period of GDP growth to run above potential to return the economy to its equilibrium,” said National Bank economist Tyler Schleich, in an interview with Canadian Mortgage Trends.

“That’s why our forecast involves a year of the policy rate at 2.25%. Once the economy picks back up and slack is absorbed, the BoC will be able to return the policy rate to neutral, which we view as 2.75%.”

A neutral rate is when interest rates neither stimulate nor hinder economic growth prospects.

If the Canadian economy could weather the trade headwinds, could interest rates go up? The views are mixed.

As for the broader outlook, the National Bank is the only financial institution projecting rate hikes next year. Scotiabank anticipates a higher-for-longer three-per-cent policy rate in 2025 and 2026. The rest of the Big Six—BMO, CIBC, Royal Bank, and TD—forecast continued rate cuts.

In fact, based on BMO’s current forecast, the Bank of Canada could reduce the policy rate to 1.5 per cent by the year’s end should the United States slap trade levies on Canada.

“If tariffs are actually put in place, then -150bps enters the realm of possibilities again,” BMO economist Michael Gregory told Canadian Mortgage Trends.

Ultimately, says David-Alexandre Brassard, CPA Canada’s chief economist, it is a difficult “balancing act.”

“If Canada retaliates to inflict economic damage on American businesses in the hopes of the U.S. lifting the tariffs faster, it would also hurt Canadian consumers,” said Brassard in a statement. “The balancing act between economic growth, inflationary pressures, and trade retaliation presents a significant challenge.”

Indeed, a boost in price inflation triggered by tariffs would lead many to conclude that interest rates are going up. However, there is an inflation difference based on what Canada has endured in the last few years: push-cost and demand-pull.

The former means that consumers face higher prices because of businesses’ higher input costs emanating from tariffs. The latter represents demand exceeding supply.

Are Mortgage Interest Rates Going Up?

Now, what does this mean for mortgage rates?

With the Bank of Canada firmly entrenched in its easing cycle, mortgage rates have gradually come down. According to the Canada Mortgage and Housing Corporation (CMHC), the conventional five-year mortgage lending rate was 5.35 per cent in December 2024, down from 6.39 per cent in December 2023.

The five-year mortgage rate follows the benchmark five- and ten-year government bond yields, which are trading at around 2.65 and 2.97 per cent.

As investors start baking more interest rate cuts into the cake, bond yields will fall—and so, too, will mortgage rates. Whether this will stimulate demand and raise home prices remains to be seen. The economic environment will undoubtedly experience many variables in the coming months.

The next significant headwind is the negotiation process surrounding the USMCA, the successor to the North American Free Trade Agreement (NAFTA). These are, indeed, tariff-ying times.