To summarize, Canada’s dependence on the US market underscores the importance of a new Canada-US trade deal that rolls back tariffs. The resilience of the economy and the labour market will also depend on the ability of businesses to expand to new markets within Canada and overseas, as well as on Canadian investment in infrastructure to get our goods to new markets.
Inflation is . . . complicated
At the Bank, we are focused on where inflation is going—the underlying trend. That’s why it is so important to understand the forces at work on inflation—which ones are temporary and which ones may last. That’s easier said than done—and right now, it’s complicated.
Once again, I’ll start with where we were before tariffs. Headline inflation was back down to the 2% target last summer. Core inflation, which strips out volatile components like energy, was still a bit higher than headline. But by the end of 2024, there were no signs of broad-based price pressures, and inflation expectations had largely returned to normal. Monetary policy had worked to restore low inflation.
But then US tariffs arrived. Assessing the inflationary impact of tariffs has been a moving target because the United States has repeatedly changed the size and scope of tariffs. The prospect of a new Canada-US trade deal offers hope that tariffs will be removed. But until we have a deal, inflation will be affected by both US tariffs and Canadian counter-tariffs. So let’s consider what each of these could mean for inflation.
I’ll start with US tariffs. As we’ve seen, tariffs have lowered our exports and weighed on employment. That puts downward pressure on inflation in Canada. However, the increase in US tariffs raises prices in the United States, and that can spill over into Canada when we import those higher-priced US goods, putting upward pressure on inflation here.
Then there are the Canadian counter-tariffs. These also make US imports more expensive and put upward pressure on inflation.
The net effect of tariffs on inflation is difficult to gauge. It’s not as easy as saying a 10% tariff will increase the price of a product by 10%.
The pass-through of higher costs from tariffs will depend importantly on demand and on inflation expectations. If the economy slows and employment continues to weaken, the drop in demand will make it harder for businesses to raise prices to reflect the full cost of tariffs. On the other hand, tariffs give companies something to blame for higher prices. That may make it easier for them to pass on the cost of tariffs. And higher inflation expectations could also make it easier because people won’t be surprised to see higher prices.
History offers some guidance on the impact tariffs could have on inflation. During the 2018 tariff conflict with the United States, the retaliatory tariff on final goods was 10% and remained in place for just under a year. During that conflict, the pass-through from price increases to consumer goods was high but incomplete. If the current tariffs and counter-tariffs remain in place, past experience suggests pass-through of about 75% of the costs of tariffs over roughly a year and a half.
So what tariff effects are we seeing in inflation so far? It’s still too early to see the direct effects of counter-tariffs in the inflation data, but we may be seeing some indirect effects related to trade disruption. Many businesses report they are already facing higher costs related to finding alternative suppliers and developing new markets.
Inflation is also being affected by other factors. In particular, the elimination of the consumer carbon tax knocked 0.6 percentage points off inflation, mostly due to lower gasoline prices, and pulled headline inflation down to 1.7% in April. This tax effect will remain in the year-over-year change in the consumer price index for the next 11 months before falling away.
Excluding taxes, inflation was 2.3% in April, slightly stronger than the Bank had expected and up from 2.1% in March. The Bank’s preferred measures of core inflation, as well as other measures of underlying inflation, moved up in April. There is some unusual volatility in inflation, but these measures suggest underlying inflation could be firmer than we thought. Higher core inflation can be partly attributed to higher goods prices, including food, and may be starting to reflect new costs related to US tariffs.
The Bank will be watching measures of underlying inflation closely to gauge how inflationary pressures are evolving.
The role of monetary policy
At the Bank, we’re keeping a close eye on the job market and inflation. Further weakening in the job market will put more downward pressure on inflation. But if tariffs were to continue, they’ll add costs. As I have said before, we can’t let a tariff problem become an inflation problem.
Two weeks ago, the Bank’s Governing Council maintained the policy interest rate at 2.75%. This was our second hold after seven straight cuts. This included the cuts in January and March in the face of US tariff threats and increased uncertainty.
Yesterday, we published the summary of Governing Council’s deliberations leading to the June 4 interest rate decision. As reported, three factors particularly weighed on our decision. Uncertainty was still high. The Canadian economy was softer, but not sharply weaker. And there has been some additional firmness in recent inflation data.
We also noted that the weaker the economy and the more downward pressure on inflation, the more there would be a need to lower the policy interest rate further. However, if the recent firmness in underlying inflation were to persist, it would be more difficult to cut the policy rate. Overall, my colleagues on Governing Council and I agreed there could be a need for a further reduction in the policy interest rate if the effects of US tariffs and uncertainty continued to spread through the economy and cost pressures on inflation were contained.
The recent progress toward a new trade deal is encouraging, and we are following developments closely. We are all invested in the future of the trade relationship between Canada and the United States.
Conclusion
It’s time to wrap up.
I came to St. John’s to talk about the global trade war and its impact on Canada’s economy.
Canadian exports have fallen sharply owing to US tariffs. This is slowing the economy and weakening the labour market. That will put additional downward pressure on inflation. But if tariffs are not removed, we expect they will be passed through to higher consumer prices. These economic impacts underline the importance of a new trade deal with the United States.
They also underscore the need to learn from this experience. Newfoundland and Labrador’s success in diversifying its markets and products shows us the way. The United States will always be our single biggest trading partner, but we can improve our resilience and grow our prosperity by expanding both our internal trade and overseas markets for our products.
At the Bank of Canada, our focus is on supporting economic activity and jobs, while ensuring inflation remains well controlled. We will maintain price stability over time for Canadians.
Thank you.
I would like to thank Fares Bounajm, Erik Ens and Olena Senyuta for their help in preparing this speech.
