Amid a raft of economic crosscurrents, the Bank of Canada is expected to cut interest rates by a quarter point at its upcoming meeting. However, some economists say a pause may not be far off.
Most observers believe an interest-rate cut is likely this time around. The domestic economy has barely grown, overall inflation remains contained, and the Canadian dollar is limping. However, a strong jobs report for December raised questions about a potential growth pickup. At the same time, the threat of punitive Trump tariffs on Canadian exports looms.
“The Bank of Canada is likely to cut by another 25 basis points at its January meeting, given the underlying trend inflationary trend, tepid aggregate demand, and a still-fragile labor market,” says Dustin Reid, chief fixed income strategist at Mackenzie Investments.
Odds Stacked for a 0.25% Cut
Last year, the Bank of Canada slashed rates at five consecutive meetings between June and December, lowering its key overnight interest rate from its peak of 5.00% to 3.25%—the top end of the neutral range (wherein rates neither constrict nor spur economic growth) of 2.25%-3.25%.
Inflation News Seen Giving Green Light for Cuts
Citi economist Veronica Clark says the softness in the recent inflation report likely solidified the odds of a cut. “Officials have likely been leaning toward another [25-basis-point] cut at the January meeting, as growth forecasts, and possibly inflation forecasts, will likely be lowered in the update next week,” she explains.
Capital Economics North American economist Thomas Ryan says any recent pickup in economic activity will be eclipsed by a far bigger threat from across the border. “We think the [proposed 25%] tariff threat hanging over the [Canadian] economy will sway the Bank of Canada to cut its policy rate by 25 basis points next week,” he says. Further, in an investor note, he pointed to the more hawkish messaging from the central bank at its last policy announcement as the reason that “the markets are pricing in a 17% chance that the Governing Council will leave rates on hold next week, compared to an 83% chance of a 25 basis-point cut.”
At its last policy announcement in December, the Bank of Canada’s governing council dropped the previous dovish tone, conveying a data-dependent approach to future interest-rate decisions. Yet policymakers may shrug off the Consumer Price Index reading for December. The report showed a slowdown in headline inflation, due largely to the temporary sales tax holiday that started Dec. 14, which brought down the prices of a basket of goods for everyday consumption. Since core inflation measures for December were also softer, “that will add to confidence that inflation is easing and policy rates can be closer to a neutral setting,” says Clark.
Will the Bank of Canada Soon Put Cuts on Ice?
Some market watchers are hedging their bets, noting a nonzero possibility that the central bank may stand pat. Clark says it could skip a rate cut next week, though a skip is more likely in March. “This may be out of concern of substantial policy divergence with the [US] Fed and resulting weakness in the Canadian dollar,” she explains.
Desjardins macro strategist Tiago Figueiredo expects a 25-basis-point cut next week, with a high probability of a March hold. At next week’s announcement, “central bankers will be keen to emphasize a slower pace of easing, which I think opens the door for a potential pause in March,” he says. He adds that part of that reasoning stems from the latest CPI readings, which appeared firmer than central bankers liked.
Given how the economic data has evolved since the December meeting, Ryan finds it understandable that some think the central bank could pause. “The recent pickup in GDP growth and core inflation pressures could justify a pause from the Bank of Canada next week,” he says. “With tariffs clouding the economic outlook, we judge that the Governing Council will opt for a 25-basis-point policy rate cut.”
Watching Bank of Canada Growth Expectations
Growth concerns remain central to policy decisions. Clark says GDP forecasts will likely be revised downward next week. Coupled with persistently high unemployment, this would support another rate cut. However, she stresses that “officials would frame concerns over the growth outlook in terms of what it would mean for inflation, [as] softer growth means more downside risk.”
Reid views steep trade tariffs, which Donald Trump says could come into effect as early as Feb. 1, as a great concern for stable inflation in Canada in the months ahead. “A 25% across-the-board tariff on all Canadian goods imported into the United States and reciprocal measures on US goods imported into Canada would have a material impact on near-term inflation,” he argues. However, instead of focusing on the near-term inflationary hike, he says the Bank of Canada would be “more concerned with much slower aggregate demand and GDP over the medium term, leading to a material easing of policy rates.”
In a note to investors, Royal Bank of Canada chief economist Frances Donald explains that tariffs tend to increase costs, which is inflationary, but also weaken an economy, which is deflationary. She says central banks rarely worry about tariff-driven inflation, as tariffs raise prices once without adding to year-over-year inflation. The drop in demand resulting from an inflation spike could be more damaging. “How the Bank of Canada will respond to this environment is unclear, but it has implications for other sectors like housing that could offset further interest rate cuts,” she stresses.
Tariffs Key to the Interest-Rate Outlook
Clark expects three consecutive 25-basis-point cuts after next week, at the March, April, and June meetings. Her forecast for interest rates by year-end is “2.25%, with a risk of lower.”
How well Canada fares in a tariff fight will significantly affect how the central bank maneuvers its policy levers. Ryan predicts that the Trump administration will apply the same 10% tariff to Canada as it does to the rest of the world. “Thanks to the recent weakening of the exchange rate, which offsets the hit to competitiveness, this should only dampen growth rather than cause a recession,” he says. After the January meeting, he forecasts the bank will make two more quarter-point cuts, lowering the policy rate to 2.5% by year-end.
However, all bets are off if Canada is hit with the full 25% export tax and a tit-for-tat trade war ensues. “The potential for the imposition of tariffs by the Trump administration, and a response from Canada, could alter inflation and growth dynamics,” says David Doyle, head of economics at Macquarie Group. He adds that the timing of any such tariffs, along with broader economic data and any fiscal policy response, “could have a significant impact on the likely trajectory for the Bank of Canada.”
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