The Bank of Canada is being pulled in a few different directions ahead of its first interest rate decision of the year on Wednesday.
On one hand, there are signs of trouble bubbling up in underlying inflation that could make an argument for keeping borrowing costs higher for longer.
On the other: fears of a trade war with the United States. President Donald Trump has reiterated threats to impose tariffs of 25 per cent on Canadian goods that could be set to take effect mere days after the central bank’s rate decision.
“If Trump were to carry out those 25 per cent tariffs, and they were in place for some time, unfortunately a recession in Canada would be inevitable,” says Stephen Brown, deputy chief North America economist at Capital Economics.
A trade blow like that would normally push the Bank of Canada towards steeper rate cuts in a bid to salvage economic growth. But dropping rates too quickly at a time when the loonie is already struggling risks fuelling more inflation on imports from south of the border.
What’s a central bank to do?
Economists who spoke to Global News say they’re betting the Bank of Canada will go ahead with another cut to its benchmark interest rate on Wednesday, albeit a smaller one than in the central bank’s recent outings.
Markets expect another cut
The Bank of Canada’s benchmark interest rate broadly sets the cost of borrowing across the country and acts as a signal for rates Canadian gets on key loans like home mortgages.
The central bank has cut its policy rate a total of 1.75 percentage points in five consecutive decisions, trimming by 50 basis points in October and December amid signs of weakness in the economy and growing fears that inflation could drop too far below the two per cent target.
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The policy rate now stands at 3.25 per cent, the top of what economists consider the “neutral range” where borrowing costs are neither stimulating nor restricting growth.
Money markets last week had priced in odds as high as 81 per cent of a quarter-point cut coming on Jan. 29, according to Reuters.
After moving quickly to lower the rate in 2024, Bank of Canada governor Tiff Macklem signalled after the most recent rate decision last month that monetary policymakers may adopt a more “gradual pace” of easing in 2025.
Brown questions whether the Bank of Canada needed to move as quickly as it did in its most recent decisions amid signs the economy likely accelerated heading into the end of 2024 as previous rate cuts started to provide a pick-up in growth.
Inflation has meanwhile remained largely under control, cooling to 1.8 per cent in December, thanks in no small part to Ottawa’s GST/HST “holiday.” But economists have noted the three-month moving averages of so-called “core inflation” are holding stubbornly above three per cent.
Cutting interest rates further right now also risks driving the already-weak loonie even lower amid expectations that the U.S. Federal Reserve will pause its own rate cuts this week. A weaker Canadian dollar can also fuel inflation by making imports more expensive.
Benjamin Reitzes, BMO’s managing director of Canadian rates and macro strategist, says the inflation data alone does not make the argument for another interest rate cut at the Jan. 29 meeting.
Tariff threats alone enough to do damage
But then there’s the question of tariffs.
Reitzes notes that Trump doesn’t have to follow through on his tariff pledge for these threats to make a dent in Canada’s economy. Businesses are likely to slow their investment in Canada amid the uncertainty alone; the central bank’s own survey of firms released last week showed two in five expect negative impacts from Trump’s presidency.
In short, Canada’s economy is expected to take a hit from Trump — how big that dent ends up being depends on whether the tariffs are implemented, how big they are and how long they stay in place, or if they remain just tough talk.
Reites adds to the mix that, despite the talk of slowing the pace of easing, the Bank of Canada’s “bias” was still tilted towards further cuts.
“You put all that together, it makes sense to cut rates 25 basis points … even if the inflation numbers maybe don’t point in that direction,” Reitzes says.
Brown agrees that the Bank of Canada would likely “shrug off” concerns about inflation and a weaker loonie if tariffs were implemented. But he says it’s “certainly not a not a clear-cut decision” for the central bank this week.
Where the Bank of Canada goes for the rest of 2025 is up in the air, though Reitzes and Brown both see the policy rate falling lower.
Each are pencilling in three more interest rate cuts this year to bring the policy rate down to 2.5 per cent, though Reitzes notes that rates will fall more sharply if tariffs are put in place.
On the other hand, he says if the U.S. Fed cuts less than expected amid a resilient economy, the Bank of Canada may also limit how low it goes in 2025.
The Bank of Canada will also release an updated monetary policy report — its first since Trump’s re-election — alongside the rate decision on Wednesday.
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Tariff uncertainty hangs over Bank of Canada’s 1st rate decision of 2025
