‘In an extreme case, market volatility could turn into market dysfunction,' says Bank of Canada
There is considerable uncertainty surrounding the evolution of U.S. trade policies and their impact on the economy, according to a recent report from the Bank of Canada.
“US trade policy has taken a dramatic protectionist shift,” say Governor Tiff Macklem and Senior Deputy Governor Carolyn Rogers, with the bank. “Tariffs and uncertainty have sharply reduced prospects for global economic growth. And financial markets have been rocked by chaotic policy announcements and reversals.
“A long-lasting trade war poses the greatest threat to the Canadian economy. It also increases risks to financial stability.”
Two scenarios amid tariffs
The Bank outlines two possible scenarios regarding the tariffs and their economic implications:
- Scenario 1: Most tariffs imposed since the trade conflict began are negotiated away, but the process remains unpredictable. Uncertainty about trade policy continues until the end of 2026.
- Scenario 2: The uncertainty and limited tariffs in Scenario 1 persist, while additional U.S. tariffs are imposed. A long-lasting global trade war unfolds.
In Scenario 1, global and Canadian growth weaken temporarily before recovering. Inflation in Canada falls to around 1.5% for one year—primarily due to the removal of the consumer carbon tax—before returning to the 2% target, according to the report.
In Scenario 2, a prolonged global trade war featuring large and permanent tariffs results in severe economic consequences for Canada, including a year-long recession. Inflation temporarily rises above 3% in mid-2026 before eventually returning to the Bank’s 2% target..
“Taken together, the scenarios frame many plausible paths for Canadian inflation and GDP growth, but uncertainty about how the economy would respond to tariffs is not entirely captured in these scenarios. These uncertainties are treated as risks.”
Canadian businesses are increasingly pessimistic as the ongoing trade war initiated by U.S. President Donald Trump continues to impact the economy, according to a previous report. And Canadian small businesses are facing unprecedented pessimism as tensions escalate in the U.S.–Canada trade dispute, according to a previous report from the Canadian Federation of Independent Business (CFIB).
Macklem and Rogers note: “In the near term, the unpredictability of US trade policy could cause further market volatility and strains on liquidity. In an extreme case, market volatility could turn into market dysfunction.”
Vulnerable Canadian businesses
Businesses most vulnerable under this scenario include highly leveraged manufacturers with low profitability and limited cash reserves, according to Bank of Canada. Firms heavily reliant on exports to the United States would be particularly exposed to declines in demand and rising input costs, with the potential for increased defaults and credit losses for banks. Domestic-focused industries could also be affected over time as broader economic demand weakens.
The trade tension has been hampering companies investment intentions, according to the report.
Previously, Prime Minister Mark Carney announced his plans to create a $2-billion Strategic Response Fund that will boost the auto sector’s competitiveness and protect manufacturing jobs.
