Bank of Canada cuts interest rate to 3%,US tariffs looming

The Bank of Canada trimmed its overnight interest rate 25 bps to 3.0%, the sixth consecutive cut for a cumulative reduction of 200 bps.

The move was as expected and cements the Bank’s title of most aggressive cutter in the world. In addition, in a bit of a surprise, the Bank also abruptly ended quantitative tightening, and will begin term repos in early March. And, in another technical move, the Bank widened the spread between the Bank rate and deposit rate, with the latter now 5 bps below the overnight rate, which should help pressure CORRA back toward target, explained Douglas Porter, Chief Economist at 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,” said Porter.

The Bank’s commentary today:

“In Canada, 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.

“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.

“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.

“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.

“Setting aside threatened US tariffs, the upside and downside risks around the outlook are reasonably balanced. However, as discussed in the MPR, a protracted trade conflict would most likely lead to weaker GDP and higher prices in Canada.

“With inflation around 2% and the economy in excess supply, Governing Council decided to reduce the policy rate a further 25 basis points to 3%. The cumulative reduction in the policy rate since last June is substantial. Lower interest rates are boosting household spending and, in the outlook published today, the economy is expected to strengthen gradually and inflation to stay close to target. However, if broad-based and significant tariffs were imposed, the resilience of Canada’s economy would be tested. 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.”

James Orlando, Director and Senior Economist, TD Economics, said the slowdown in the pace of interest rate cuts was widely expected.

“This more conservative approach makes sense for an economy that churned out 91k jobs last month and is likely to see solid GDP growth for the fourth quarter of 2024 of around 2%. At the same time, inflation remains under control, allowing the BoC to focus on the state of the economy. This approach also mitigates the risk that the policy rate diverges too much from the Fed (which is clearly on hold). The loonie remains under pressure, but seems to have stabilized at around 69 U.S. cents,” he said.

“The economic outlook has become highly uncertain with Donald Trump threatening to make an announcement on tariffs this Saturday. Canada exports $1.9 billion daily in goods and services south of the border. This sums to around 20% of Canada’s economy, with nearly two million jobs dependent on U.S. trade. 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 remains 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.”

Related Retail Insider stories:

• Business leaders want Canada to fight U.S. tariffs with corresponding dollar-for-dollar tariffs: KPMG
• A cloud of uncertainty looms: Conference Board of Canada