The Bank of Canada's strongest stagflation warning: Tariffs could cause fourth-quarter growth to fall below 1%, and high oil prices exacerbate inflation.
Bank of Canada Governor John Macklem issued his clearest signal yet of stagflation on Monday: a new round of U.S. tariffs could cause Canada’s fourth-quarter economic growth to fall below 1%, while annual inflation will remain at 3%, above the 2% target, and oil prices could further push up prices if they remain around $100 a barrel.
Macklem made it clear that the latest round of tariff escalation "could again prompt businesses to postpone investment and hiring decisions," and that if the new tariffs continue to be implemented, the economic growth rate in the fourth quarter could be "roughly halved," falling below 1%.
This warning signifies a substantial downward revision of the central bank's assessment of the economic outlook. Canada's economy still grew at an annualized rate of 3.3% in the second quarter, but this momentum primarily stemmed from a one-off adjustment by businesses and households following nearly 18 months of trade friction, and is rapidly fading as tariff uncertainty resurfaces.
The coexistence of slowing growth and persistent inflation has drastically narrowed the central bank's policy space. Macklem stated, "If inflationary pressures are under control, we do not want to curb economic growth by raising interest rates. But if inflationary pressures continue to exceed expectations, we also do not want to react too slowly."
Tariff shock: Growth momentum rapidly fading
In July, the Bank of Canada projected third-quarter economic growth of 1.5%, before the latest round of tariffs was announced. Now, the impact of the escalating tariffs is being transmitted to the real economy through delayed business investment and hiring decisions.
McClellam points out that since the start of the trade friction, companies have been adjusting their supply chains and procurement strategies to mitigate tariff risks, but the marginal effect of these adaptive adjustments is diminishing; the new round of tariffs has directly impacted companies' confidence in making long-term capital expenditures and hiring.
The postponement of investment and employment will further impact household consumption. Slowing population growth and an aging population have already structurally dragged down labor supply and consumer demand; the tariff shock amplifies this downward pressure.
McClellam also mentioned that companies are actively introducing artificial intelligence technology, but its effect on improving productivity will take time to materialize and cannot offset the risk of slowing growth in the short term.
High oil prices: Inflation continues to exceed target
While growth is slowing, inflationary pressures have not subsided. Canada's annual inflation rate is currently 3%, higher than the central bank's 2% target. Tensions in the Middle East have impacted crude oil prices and hampered gasoline and diesel supply, further pushing up fuel costs.
Macklem made it clear that if oil prices remain around $100 a barrel, inflation could rise further.
The key question is whether rising oil prices will escalate into broader inflationary pressures. Macklem stated that while the risk of broader inflation has increased, there is currently no evidence that rising fuel costs have spread to other goods or services.
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