Derek Holt has forecast a 25-basis-point overnight rate cut by the Bank of Canada on Wednesday, but he believes it’s a mistake.
In a colourful note to investors on Monday, Scotiabank’s vice-president and head of capital markets economics, laid out his argument for standing pat in light of Canada’s solid job numbers, decent consumer spending and U.S. President Donald Trump’s tariff threats.
“The BoC conducts monetary policy over a 12-24 month monetary policy horizon,” he wrote. “A surge of inflationary pressure over this period that stems from this trade shock would not be ignored.”
Holt wrote that if 25% tariffs are applied on Canadian goods shipping into the U.S., a lot is riding on whether or not Ottawa retaliates.
“Tariffs imposed on Canadian exports with no carve-outs for a meaningful period of time and — this is key — with no retaliation by Canada invite further easing,” he wrote. “The economy would be tossed into recession, unemployment would rise, pricing power would be crushed, taking inflation down with it. That’s a recipe for combined monetary, fiscal and regulatory easing.”
If Ottawa slaps back?
“Now that’s a different tale and a much bigger threat over time,” Holt wrote. “Import tariffs applied by Canada would raise prices paid by Canadians. A greater tumbling by the currency would add price pressures. Supply chains that are still at a nascent stage of being revamped at home and globally would be severely disrupted in a version of the pandemic.”
This scenario blows up the Bank of Canada’s 2% inflation target and could trigger a fresh round of tightening.
“Naturally, the patriotic ‘America First’ thing to do [would] be for American companies to hike prices — on their fellow Americans,” he wrote. “[T]hat’s hardly a surprise to anyone who knows anything about history or who might have heard of a fella named Adam Smith.”
He didn’t stop there.
“If trade wars persist for a lengthy period — à la [President William] McKinley, or Smoot-Hawley — then it is probably long-term deflationary,” Holt wrote. “Maybe Ben Bernanke can help out Mr. Trump with a lesson on the various factors leading up to the Great Depression.”