David Rosenberg: Bank of Canada has made a big mistake by being so timid

Bank of Canada governor Tiff Macklem and his team held rates this month. Photo by TONY CALDWELL/Postmedia

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The Bank of Canada decided to stand pat at its most recent meeting, which it will come to regret.

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The central bank also pulled forward guidance and laid out two scenarios: one was the unalloyed hope that United States President Donald Trump will unwind most of this trade war, which is wishful thinking, and the other was a fairly deep recession premised on the current tariff threats being carried out and remaining in place.

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Policymakers did not handicap the odds, but even if there is a non-trivial chance of that second scenario occurring, then the Bank of Canada, as a risk manager, should have taken out an added insurance policy. Based on the ominous second scenario, it acknowledged that:

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“The output gap reaches about minus 1.7 per cent in the first quarter of 2026 and then narrows somewhat over the rest of the scenario horizon. Excess supply in the economy exerts downward pressure on inflation over the entire scenario horizon. This pressure is most apparent in prices in the services sector, which are not directly boosted by tariffs.”

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The Bank of Canada needs to recognize that the country is in an economic war, and it should be protecting us against a fat-tailed risk. If scenario No. 2 plays out, the policy rate is going to have to be pulled all the way down below two per cent.

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A worst-case scenario, which should have been a third published scenario where the output gap goes to minus 3.6 per cent and core inflation decelerates to 1.5 per cent, would indeed mean the overnight rate is heading back to the zero bound.

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That is precisely the conclusion reached by the Taylor Rule. We were fortunate to have Bank of Canada governor Tiff Macklem and crew realize it overshot in the last tightening cycle and too quickly begin a process of correcting that policy misstep.

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But I can’t help but feel a valuable opportunity was missed last time out to further ease monetary policy and provide support to an economy that was struggling even before the onset of the Trump tariff war.

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Furthermore, given the headline unemployment rate, at 6.7 per cent, and the all-inclusive R-8 measure at 9.5 per cent, our research shows that the current disinflationary “output gap” is closer to minus two per cent than the central bank’s newly minted minus one per cent to zero per cent band.

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Ergo, policymakers should already have navigated to the lower end of the 2.25 per cent to 3.25 per cent range for the neutral nominal interest rate instead of sitting at the midpoint.

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At least the European Central Bank (ECB) gets it. Even with its core inflation rate higher than Canada’s, it still lowered its benchmark rate last Thursday to 2.25 per cent from 2.50 per cent, the seventh cut in eight meetings. And it didn’t monkey around with scenarios, but just told the public what they needed to know: “The economic outlook is clouded by exceptional uncertainty.”