Scotiabank's Forecast: Bank of Canada to Maintain Rates Amid Trade Uncertainty

The Bank of Canada’s (BoC) next steps on interest rates have become a focal point for investors, and Scotiabank’s recent analysis has sparked debate. The Canadian bank predicts the BoC will keep its overnight policy rate steady at 2.75% through 2026, diverging from more dovish forecasts from peers like BMO and RBC, which anticipate further cuts to as low as 2.00%. This stance hinges on escalating global trade tensions, particularly U.S. tariff threats, which risk derailing Canada’s economic stability.

The Case for a Rate Hold

Scotiabank’s prediction is rooted in three key factors:

1. U.S. Trade Policy Volatility:
   Persistent uncertainty around U.S. tariffs—such as proposed 25% levies on Canadian and Mexican exports—has already dampened business and consumer confidence. While these tariffs are delayed until April 2025, their mere threat has disrupted supply chains and raised input costs for Canadian firms. The BoC’s March 2025 rate cut to 2.75% aimed to counteract the drag on growth, but Scotiabank argues further easing is unnecessary unless trade disputes escalate.

2. Inflation Risks:
   Current inflation is near the BoC’s 2% target, but tariff-driven cost pressures could reignite upward momentum. Governor Tiff Macklem has warned that avoiding a “tariff shock becoming an inflation shock” is critical. Should tariffs materialize, the BoC may need to raise rates—a stark contrast to its current accommodative stance.

3. Economic Softening:
   Canada’s GDP growth is projected to slow to 1.7% in 2025 and 1.5% in 2026, levels that the BoC deems manageable with its existing stimulus. Recent rate cuts have already provided support, and further reductions risk overstimulating an economy already navigating trade-related headwinds.

Economic Implications: A Delicate Balance

The BoC’s dilemma is twofold:

• Domestic Growth vs. Global Shocks:
  Canada’s economy remains deeply intertwined with the U.S., its largest trading partner. U.S. growth is forecasted to lag at 1.4% in 2025, its slowest pace in decades, as tariff-driven uncertainty stifles investment. A prolonged trade war could push Canadian GDP below U.S. levels, exacerbating risks to sectors like automotive and energy.

• Monetary Policy Constraints:
  The BoC’s toolkit is limited in addressing trade-related disruptions. While it can cut rates to support demand, tariffs require diplomatic solutions. The April 2025 Monetary Policy Report highlighted that Scenario 2—a prolonged trade war—could shrink Canadian GDP by 1% and push unemployment above 7% by late 2025.

Contrasting Forecasts: Why Scotiabank Stands Out

While most banks anticipate further cuts, Scotiabank’s caution aligns with Oxford Economics, which projects the BoC’s rate will stay above 2.25% unless trade tensions ease. BMO, however, emphasizes inflation control, arguing that tariffs alone cannot offset monetary policy. This divergence underscores the high stakes of U.S.-Canada trade relations.

Investment Implications

For investors, the BoC’s hold policy suggests:
- Fixed Income: Canadian bonds may see limited gains, as low-rate expectations are already priced in.
- Equities: Sectors reliant on U.S. trade (e.g., automotive, energy) face downside risks, while defensive sectors like utilities could outperform.
- Currency: The Canadian dollar’s weakness (<70¢ USD in Scenario 2) may pressure import-reliant industries but boost exporters’ competitiveness.

Conclusion: Navigating Uncertainty

Scotiabank’s call for a BoC rate hold through 2026 is a prudent reflection of today’s volatile landscape. With U.S. tariffs posing a binary risk—either easing tensions or triggering recession—the central bank must tread carefully. If trade disputes escalate, Canada’s GDP could contract by 1% in 2025, pushing unemployment to 7%+. Conversely, a resolution might allow the BoC to cut rates further.

Investors should prioritize flexibility, favoring sectors insulated from trade shocks and monitoring the BoC’s next moves. The April 16, 2025, Monetary Policy Report, which underscored “pervasive uncertainty,” serves as a reminder: in an era of geopolitical volatility, caution remains the watchword.

Data sources: Bank of Canada reports, Scotiabank analysis, Oxford Economics forecasts.