When it left its key policy rate unchanged for the second time at 2.75% at its June 4 meeting, the Bank of Canada said it needed more information about the U.S. trade policy and its net impact on inflation and economic growth before making its next move.
The central bank added it was proceeding with caution and without being as forward-looking as usual given the amount of uncertainty: it evaluates as it goes.
It is particularly watching four key areas:
- Export Damage: To which extent do higher U.S. tariffs reduce demand for Canadian exports?
- Economic Spillover: How much does the export damage spill over into business investment, employment and household spending?
- Price Pass-Through: How much and how quickly are cost increases passed on to consumer prices?
- Inflation expectations: How are inflation expectations evolving?
Here is what the data has shown since June 4.
1. Export damage
After increasing as businesses built up inventories prior to tariff implementation, Canadian exports to the U.S. have dropped significantly: -15.7% in April and -0.9% in May, with motor vehicles and parts particularly affected. The share of goods exports to the U.S. compared to total exports has fallen to 68.3% in May, one of the lowest levels on record.
The Bank of Canada Q2 Business Outlook Survey (BOS) shows that tariffs and uncertainty continue to weigh heavily on business outlooks.
Manufacturing sales data show that approximately half of manufacturers have been impacted by tariffs, leading to reduced sales, especially in transportation equipment, machinery, and primary metals. Ontario experienced the largest sales decline.
The latest developments have further raised uncertainty as U.S. President Donald Trump has threatened to impose 35% tariffs to all Canadian goods starting in August if no deal was reached with Canada. Canada Prime Minister Mark Carney’s messaging has also shifted to lower expectations regarding the outcome of negotiations.
Currently, the U.S. is applying 25% tariffs on autos and 50% on steel and aluminum.
Overall, the tariff-driven export weakness is evident, but expected.
2. Economic spillover from export damage
Canada’s GDP contracted 0.1% in April and advance indicators point to another 0.1% decline in May. The manufacturing sector contracted 1.9%, specifically motor vehicle manufacturing, due to tariff uncertainty and scaled-back production.
Some motor vehicle manufacturers scaled back production amid uncertainty related to tariffs imposed on motor vehicle exports to the United States – Statistics Canada reported.
The central bank had expected the economy “to be considerably weaker in the second quarter” after a stronger-than-expected performance in the first quarter. Does -0.1% qualify as significantly weaker, to the point of warranting a rate cut while core inflation remains above target? Probably not.
Jobs market
The jobs market has proved unexpectedly resilient, with over 80,000 jobs created in June, although mostly part-time.
The unemployment rated edged down to 6.9% in June from 7.0% in May. but job security concerns elevated in trade-reliant sectors. Also, job seekers have difficulty finding new jobs.
While employment has increased, over one in five unemployed people (21.8%) had been searching for work for 27 weeks or more in June, an increase from 17.7% in June 2024.
With this mixed picture, households have been cautious with their spending, with real retail sales down 1.4% in May. The Bank of Canada Q2 Canadian Survey of Consumer Expectations (CSCE) also reported “persistent threats of tariffs and related uncertainty” leading to lower spending intentions. Consumers are becoming more cautious about discretionary spending overall.
Statistics Canada said 32% of retailers were impacted by trade tensions in May. This is significant but down from 36% in April. Those impacted report experiencing negative impacts on sales across all subsectors.
In the Q2 Business Outlook Survey, firms reported a weakening of near-term sales expectations, driven by broad spillover effects including weak consumer spending, low housing activity, and soft sales outlooks.
Business investment
Trade uncertainty and tariffs are causing some employers to hold off on investing.
Most firms expect to maintain current staffing levels and limit investment to regular maintenance over the next 12 months – Q2 Business Outlook Survey.
3. Price pass-through
The uncertainty surrounding international trade is putting upward pressure on prices.
Overall consumer prices increased 1.9 % in June in June after 1.7 % in May. Core inflation is sticky and remains above the BoC’s 2% target. The central bank’s own core measures remain close to the upper end of the 1%-3% operational range.
Manufacturers reported price increases and higher expenses for raw materials, shipping, and labor due to tariffs and retailers reported price increases and supply chain disruptions due to trade tensions. Wholesalers cited increased expenses for raw materials, shipping, or labor as common impacts of trade tensions.
That being said, competition is leading businesses to absorb part of cost increases through margins. For now.
4. Inflation expectations
Looking ahead, the BOS reported that 51% of businesses expect inflation to be between 2% and 3% over the next two years.
The Canadian Survey of Consumer Expectations shows that consumers believe tariffs are inflationary. In fact, they expect large increases in motor vehicle prices over the next 12 months due to tariffs.
Overall, there is definitely evidence of the impact of tariffs and related uncertainty on both inflation and activity. While the BoC clearly stated it “will support economic growth”, sticky core inflation and an economic activity that is weakening but not “considerably” limit the sense of urgency for a rate cut. The mixed picture makes it difficult to conclude whether tariffs are hurting the Canadian economy more than they’re pushing up prices. Given that the outcome of negotiations between the U.S. and Canada won’t be known by July 30, perhaps the central bank will want to wait.
