In the seminal Danish movie The Celebration (1998), a family and guests are gathered for the 60th birthday of the patriarch, Helge. Christian, the oldest son, gives Helge the choice between the yellow and the green speech. Helge chooses the green one, which turns out to be the truth-speech, and then the family unravels from there. A worthy, albeit not easy-to-watch, movie that defined the Dogme95 movement.
While I doubt that was what Governor Tiff Macklem, Bank of Canada, had in mind, he did present two pick-your-trauma scenarios for the Canadian economy over the next years.
Let’s remember that most central banks have a dual responsibility, keeping employment up and inflation down, and one hammer, interest rates, in their toolbox to achieve this. Their worst nightmare is stagflation, high inflation + high unemployment + stagnant demand, which renders the rate hammer useless because interest rates have to go up to curb inflation and down to facilitate growth.
Since June 2024, Bank of Canada has steadily cut the policy rate down because inflation has looked decent and economic growth has been less than desired, but on the way up. Now, though, things are predicted to go stagflationary, it is just how much that is in question.
The first scenario assumes that the trade hullabaloo is mostly just that. In that scenario inflation will hold steady this year and increase a little in 2026/27 when the impact from reset trade patterns will kick in. Worse is it that economic growth will take a dip in 2026, so here BoC will have to walk that narrow ledge between enough stimulation without a dopamine overload.
The second scenario is an all-out global trade war. Inflation will go out of range again, especially in 2026, when the economy will also contract. Exactly the stagflation that nobody wants.
Just as in The Celebration, thinking that there is a choice/scenario where the family/global economy can go through these events unscathed is probably an illusion.
And in the short term, uncertainty might be just as bad as stagflation because it causes paralysis. Not knowing if the turbulence is temporary can hold up expensive—but maybe necessary—investments in long-term trade reconfigurations.
Then there is a very fine line between volatility and regime shifts that can only be seen at a distance. It takes time and a number of datapoints to go from outlier to statistical significance, and in the meantime, we tend to either panic or hold our breath.
This week, Bank of Canada chose the latter and kept the policy rate at 2.75% which is also considered the new neutral rate. The same wait-and-see stance was taken by Bank of Japan and Bank of Korea, while the European Central Bank adopted what they refer to as agile pragmatism and cut their rates further, since Europe is in a fairly good place with inflation but needs the economic wheels turning a little bit faster in order to transition to greater self-reliance.
Regitze Ladekarl, FRM, is FRG’s Director of Company Intelligence. She has 25-plus years of experience where finance meets technology.
This article is part of the FRG Risk Report, published weekly on the FRG blog. To read other entries of the Risk Report, visit frgrisk.com/category/risk-report/.