The Bank Of Canada Cuts Key Interest Rate to 3%

On economic growth: “Past cuts to interest rates have started to boost the economy. The recent strengthening in both consumption and housing activity is expected to continue. However, business investment remains weak. The outlook for exports is being supported by new export capacity for oil and gas.”

On employment: “Canada’s labour market remains soft, with the unemployment rate at 6.7% in December. Job growth has strengthened in recent months after lagging growth in the labour force for more than a year. Wage pressures, which have proven sticky, are showing some signs of easing.”

On GDP: “The Bank forecasts GDP growth will strengthen in 2025. However, with slower population growth because of reduced immigration targets, both GDP and potential growth will be more moderate than was expected in October. Following growth of 1.3% in 2024, the Bank now projects GDP will grow by 1.8% in both 2025 and 2026, somewhat higher than potential growth. As a result, excess supply in the economy is gradually absorbed over the projection horizon.”

On inflation: “CPI inflation remains close to 2%, with some volatility due to the temporary suspension of the GST/HST on some consumer products. Shelter price inflation is still elevated but it is easing gradually, as expected. A broad range of indicators, including surveys of inflation expectations and the distribution of price changes among components of the CPI, suggests that underlying inflation is close to 2%. The Bank forecasts CPI inflation will be around the 2% target over the next two years.”

On the threat of U.S. tariffs on Canadian imports: “A long-lasting and broad-based trade conflict would badly hurt economic activity in Canada. At the same time, the higher cost of imported goods will put direct upward pressure on inflation. The magnitude and timing of the impacts on output and inflation will depend importantly on how businesses and households in the United States and Canada adjust to higher import prices.”

As the BoC’s interest rate decisions influence the prime rate, the ‘Big Six Banks’ and other lenders have again lowered their prime rate to 5.20%, which is good news for holders of variable-rate mortgages and other loans. 

On November 25, 2024, then President-elect Donald Trump announced his intention to impose a 25% tariff on products entering the U.S. from Canada and Mexico, and 10% from China. This action was in response to the alleged flow of undocumented migrants and illegal drugs, such as fentanyl, across the border. 

On Saturday, February 1, President Trump made the threat official, signing an executive order to start levying import tariffs on Canada and Mexico as of Tuesday February 4, 2025. Prime Minister Trudeau, in turn, announced retaliatory tariffs of 25% on American imports, including beverages, cosmetics and paper products worth $30 billion, with a second round of goods (including passenger vehicles, trucks, steel and aluminum products and certain foods) worth $125 billion to be included later. Following 11th-hour negotiations, Trump announced a 30-day moratorium on tariffs for both countries; however, Trump’s threat to impose 10% tariffs on Chinese goods took effect as of Tuesday. 

A tariff is a government-imposed tax on imported goods paid by the importer. The intent is to make foreign products more expensive and therefore reduce demand. 

According to Al Jazeera, the United States’ top trading partners–Mexico, Canada and China–account for more than 40% of goods traded, valued at more than $2 trillion. 

Before the 30-day pause was announced, BMO chief economics Douglas Porter wrote in a research note that “Trump’s tariff hammer will come down hard on the economy,” likely pushing Canada into a recession and causing unemployment to surge. 

If the proposed tariffs are imposed, economists widely believe that the BoC would cut its central policy rate faster than originally forecast for the year.

Noted Macklem in his Monetary Policy Report Press Conference Opening Statement, “Unfortunately, tariffs mean economies simply work less efficiently—we produce and earn less than without tariffs. Monetary policy cannot offset this. What we can do is help the economy adjust. With inflation back around the 2% target, we are better positioned to be a source of economic stability. However, with a single instrument—our policy interest rate—we can’t lean against weaker output and higher inflation at the same time. As we consider our monetary policy response, we will need to carefully assess the downward pressure on inflation from weakness in the economy, and weigh that against the upward pressure on inflation from higher input prices and supply chain disruptions.”

The central bank noted that projections are subject to more uncertainty than usual due to the threat of trade tariffs, but as the “scope and duration of a possible trade conflict are impossible to predict,” their forecast was made in the absence of new tariffs.

He noted that the cumulative reduction in the policy rate since last June is “substantial” and that lower interest rates are boosting household spending. What’s more, the economy is expected to strengthen gradually and inflation to stay close to target.

However, he noted that if broad-based and significant tariffs were imposed, the resilience of Canada’s economy would be “tested,” adding, “We will be following developments closely and assessing the implications for economic activity, inflation and monetary policy in Canada. The Bank is committed to maintaining price stability for Canadians.”

Douglas Porter, Chief Economist and Managing Director Economics, BMO: “Today’s steps by the Bank of Canada can be viewed as battening down the hatches ahead of a possible trade war storm. As noted, the 200 bps of cumulative rate cuts are setting a much more positive backdrop for the Canadian economy—arguably one of the most rate-sensitive economies in the world. Next steps clearly are dependent on what unfolds on the trade front; we suspect while the Bank may initially respond cautiously to a trade war, eventually it would be compelled to cut much more than the market currently expects.”

James Orlando, Director and Senior Economist, TD Economics: “We are still hopeful that tariff threats are more of a negotiation tactic, meaning they would be temporary and carry less long-term impacts. Yet, this is a tail risk that remains front and center in the mind of the BoC. Our baseline forecasts remain that the BoC will cut rates to 2.25% by year-end, but should 25% tariffs come into play for more than a few months, we’d expect the central bank to cut more aggressively in order to cushion the economy.”

Randall Bartlett, Senior Director of Canadian Economics, Desjardins: “Given the headwinds to the Canadian economy resulting from the ongoing threat of tariffs, planned slower population growth and the impending wall of mortgage renewals, we anticipate the Bank of Canada will reduce the policy rate by another 75 bps to 2.25% before 2025 is over. But if a full-blown trade war breaks out, expect the policy rate to fall faster and further.“

Taylor Schleich, Ethan Currie and Warren Lovely, Economists, National Bank of Canada: “With the promised/threatened tariff implementation date (1-Feb) still ahead of us, we weren’t surprised to see the Governing Council hold off from providing clear rate guidance. Indeed, if we were to somehow get through the coming weeks unscathed by tariffs, we could see a scenario in which the BoC leaves rates unchanged in March (assuming economic conditions continue to firm). However, that doesn’t mean there’s no scope for further rate relief this year in a ‘friendlier’ geopolitical environment. As the Bank has stressed, slack remains in the Canadian economy. Moreover, there’s an apparent willingness to look through the stickier core measures that the Bank had been focused on (CPI-Trim). To them, underlying inflation is on target. In any case, we’ll all (hopefully) have better clarity on the likely BoC rate path by next week.”

Avery Shenfeld, Chief Economist, CIBC World Markets: “While there’s a risk of some pauses along the way if any of the growth or inflation data show an uptick, we’re sticking with our call for the overnight rate to reach 2.25%, even in the absence of a trade war. Should major tariffs hit, our view is that the downward pressure on growth would provide enough disinflationary pressure over the medium term to offset the initial upward pressure on inflation coming from the trade war and a weaker C$. But the need for even more aggressive rate cuts would also depend on the fiscal policy response.”

Frances Donald, Chief economist, Royal Bank of Canada: “The BoC is fighting two particular demons that make its base case forecasts and current assessment of the state of affairs far less useful than usual. Instead, the value of their communication is in the clues they drop about how they might navigate the shocks ahead. We think most signs continue to point to further declines in interest rates, the magnitude and speed of which will be determined by the details of a potential U.S.-Canada trade conflict.”