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Photo: James Bombales

A noted economist says the uncertainty President-elect Donald Trump has created for North American markets is affecting the Bank of Canada’s decision-making process.

The Bank of Canada won’t be making any changes to the key interest rate at next week’s scheduled announcement, says Paul Ashworth, chief North American economist of Capital Economics.

“The upshot is that, if it wasn’t for the Trump uncertainty (and perhaps the surprising recent strength in the incoming labour market data), then we think the Bank would be seriously considering cutting its key policy rate to only 0.25 [per cent] next week,” he writes in the economic analysis firm’s latest Bank of Canada Watch this week.

The key interest rate, which influences mortgage rates (read more on how this works here), is already at a historically low level of 0.50 per cent. Low interest rates have encouraged Canadians to take on more debt — pushing it to record high levels — as they finance home purchases in this favourable interest rate environment.

There are several reasons why a further rate cut could spell trouble for the Canadian economy, according to one observer, not least of all because it spurs more borrowing.

Stateside, the Federal Reserve is grappling with its lack of a clear picture concerning what economic impact the Trump administration’s policies will have in the US, Ashworth notes. Canada’s national bank has similar concerns of its own.

“Unfortunately for the Bank of Canada, the impact on Canada’s economy is, somewhat perversely, even more uncertain,” the economist states. “That’s because although the prospective fiscal stimulus would be unquestionably positive for the US economy, it might turn out to be a net negative for Canada,” he adds.

Ashworth says the outcome hinges on US corporate tax rates and tariffs. “The reduction in the headline corporate tax rate, and the proposed switch to a border adjustment tax, would be big negatives for investment in Canada,” says Ashworth. The US moving to a border-adjusted taxation system would work out to a 20-per-cent tariff for Canadian imports, he estimates.

That Capital Economics expects American political uncertainty to keep the Bank of Canada on the sidelines next week has not changed its call for a rate cut later this year.

Late last year, David Madani, Capital Economics’ senior Canadian economist, said his firm expected “a more pronounced downturn in housing activity to prompt the bank to cut interest rates to 0.25 per cent” in 2017.

Capital Economics expects the Bank of Canada to trim the key interest rate by 0.25 basis points this spring when it releases another Monetary Policy Report, according to this more recent Ashworth-authored report.

“By the time the next MPR is due in April, we should have a much better idea of the details of the agreed fiscal plan and how big the lurch towards protectionism will be,” Ashworth writes.

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