With economic headwinds rising thanks to the trade war launched by the US, the Bank of Canada cut interest rates by a quarter point on Wednesday. This took the target for the key overnight rate to 2.75%, with the bank rate at 3.00% and the deposit rate at 2.70%.
The Bank has cut overnight interest rates seven times since last June, including two half-point cuts at the end of 2024. Altogether, it has lowered the overnight rate from its peak of 5%.
Leading up to the meeting, economists initially called for the Bank of Canada to pause its rate cuts. But with US President Donald Trump placing tariffs on Canadian exports, the outlook for the economy dimmed. Announcing the rate cut, the Bank of Canada said, “the Canadian economy entered 2025 in a solid position, with inflation close to the 2% target and robust GDP growth. However, heightened trade tensions and tariffs imposed by the United States will likely slow the pace of economic activity and increase inflationary pressures in Canada. The economic outlook continues to be subject to more-than-usual uncertainty because of the rapidly evolving policy landscape.”
The Bank also had some words of caution about the outlook: “While economic growth has come in stronger than expected, the pervasive uncertainty created by continuously changing US tariff threats is restraining consumers’ spending intentions and businesses’ plans to hire and invest. Against this background, and with inflation close to the 2% target, Governing Council decided to reduce the policy rate by a further 25 basis points. Monetary policy cannot offset the impacts of a trade war. What it can and must do is ensure that higher prices do not lead to ongoing inflation. Governing Council will be carefully assessing the timing and strength of both the downward pressures on inflation from a weaker economy and the upward pressures on inflation from higher costs. The Council will also be closely monitoring inflation expectations. The Bank is committed to maintaining price stability for Canadians.”
Here is commentary from economists on the Bank of Canada rate cut and the outlook.
Douglas Porter, chief economist at BMO
“Looking ahead, future decisions will be largely guided by the direction of travel in the trade war, although we suspect the Bank was headed a bit lower in any event. We continue to expect three more 25 bp cuts at the next three meetings, taking the overnight rate down to 2%. Clearly, that’s dependent on how tariffs evolve, while the eventual fiscal response could have an impact as well. Our core assumption is that Canada will be facing some serious tariffs for an extended period of time and that the growth dampening aspects of the trade war will ultimately outweigh the upside inflationary impact, keeping the Bank in easing mode.
“Bottom Line: The Bank continues to strike a balanced tone in its response to the trade war, citing both downside risks to growth but upside risks to inflation. We strongly suspect that the weak growth impact will dominate and, while the Bank’s caution means it will proceed very slowly, the ultimate destination for rates is lower than the market now expects. That’s even moreso the case if the trade war deepens further than the current planned US tariffs.”
Avery Shenfeld, economist at CIBC Economics
“A quarter-point rate cut from the Bank of Canada might only be a Band-aid, but we don’t yet know the size of the economic wound that will be opened up by US trade policy ahead. It’s clear from the statement that improving economic fundamentals in the last two quarters would have otherwise seen the central bank take a wait-and-see approach on further easing. But the Bank’s readings on business and household confidence, and its expectations for slower growth in Q2 and beyond, made the case for a rate cut.
“That said, the central bank opted to keep its cards close to its chest in terms of what it might do ahead, citing slower growth but higher inflation as likely outcomes if the trade war persists, results consistent with what they learned from a special survey of consumers and businesses. Our judgement is that the downward pressure on prices from increased slack and weaker household spending power would leave growth risks, rather than inflation, as the dominant story for monetary policy, allowing the Bank to deliver two more quarter point cuts by June. That could be the trough if tariffs come down again, as we still hope will be the case.”
Stephen Brown, deputy chief North America economist at Capital Economics
“Although the Bank of Canada cut interest rates by 25bp again today, it also warned that ‘monetary policy cannot offset the impacts of a trade war’ and that it must guard against tariff-related rises in price inflation. This confirms that the Bank is hesitant to commit to much more in the way of policy support and is a risk to our view that the Bank will cut at each of the next three meetings.
“The Bank’s decision to cut by 25bp again, with the policy rate now at 2.75%, was well anticipated given the growing downside risks to the economy from US tariffs. The accompanying policy statement noted that ‘recent surveys suggest a sharp drop in consumer confidence and a slowdown in business spending as companies postpone or cancel investments,’ while there are ‘warning signs that heightened trade tensions could disrupt the recovery in the jobs market.’ Governor Tiff Macklem will deliver a similar message in his opening statement to the press conference, noting that ‘credit has become more difficult to access for some businesses’ and ‘the cost of imported machinery and equipment has risen,’ which means many firms ‘have scaled back their hiring and investment plans.’
“Despite the growing downside risks to the economy, the Bank warned us that ‘monetary policy cannot offset the impacts of a trade war. What it can and must do is ensure that higher prices do not lead to ongoing inflation.’ The Governing Council ‘will be carefully assessing the timing and strength of both the downward pressures on inflation from a weaker economy and the upward pressures on inflation from higher costs.’ As price changes tend to follow changes in demand with a lag, whereas tariff-related price hikes will be more immediate, this raises the risk that the Bank will be slower to lower interest rates from here than we have assumed. Nonetheless, for now, we continue to expect 25bp cuts at the next three meetings until the policy rate reaches 2%.”
Royce Mendes, managing director and head of macro strategy at Desjardins
“Canadian central bankers lowered rates again today in an attempt to cushion the blow from the ongoing trade war, but reiterated that their tools are ill suited to fully offset the impacts. The Bank of Canada pushed the policy rate down another 25 basis points to 2.75%. The new level represents the midpoint of the institution’s estimated neutral rate range.
“Officials warned that further reductions are not a given, reiterating that ‘monetary policy cannot offset the impacts of a trade war.’ While central bankers anticipate that the economy will weaken in the quarters to come, higher costs as a result of tariffs are expected to feed through to inflation, leaving the policymakers with a dilemma.
“The Bank of Canada made the unusual move of publishing early survey results. The responses showed that both businesses and households expect to pull back on spending, while at the same time both groups are bracing for higher inflation in the near-term. Officials are very concerned that inflation expectations might become unmoored, stating that monetary policy must ‘ensure that higher prices do not lead to ongoing inflation.’
“Central bankers once again took solace in the fact that their preferred core inflation measures are only above target because of slow moving shelter price growth, a category they’re willing to ignore. But while that’s true of the year-over-year rate, both shelter and non-shelter prices have been accelerating more recently. The statement accompanying today’s rate cut mentions that the Bank of Canada expects headline inflation to move up to 2 ½% in March after the expiry of the GST/HST holiday, up from 1.9% in January.
“The focus on rising inflation expectations in today’s release is somewhat hawkish. Assuming that the drag from the trade war shows up only gradually and financial market volatility doesn’t translate into concerns about financial stability, a rate cut in April will depend on medium- and longer-term inflation expectations remaining anchored. Government of Canada yields are up across the curve, and the probability for a move in April has diminished.”
James Orlando, director and senior economist at TD Bank
“The BoC is taking out insurance that tariffs will persist and put significant downward pressure on the Canadian economy. While recent strength in economic data would argue that the BoC could have elected to pause rate cuts, past outperformance won’t matter much with the narrative now fully altered to incorporate a trade war. Our updated forecast will reflect a shallow recession under the assumption that Canadian exporters will face an effective tariff rate of 12.5% for at least the next six months. That’s a massive overhaul from the past when it sat below 2%.
“As long as the pressure on tariffs remains in place, the BoC should keep its dovish bias. We have the overnight rate getting to 2.25% by June, but see limitations in going further due to the delicate balance in managing inflation expectations.”
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