Will this month's cut be the last for a while or will divergence with the Fed continue?
There were very few economists who were surprised by the Bank of Canada’s decision to make a further 25-point cut to interest rates Wednesday, a day when the Fed’s decision to pause again further widened the gap between the two.
Although the Canadian central bank was widely expected to do what it did, uncertainty – a word used 42 times in Governor Macklem’s speech - now focuses on what happens next, given President Trump’s stated intention to bring in a 25% tariff on exports of some of Canada’s most important revenue generators.
Many leading economists feel that BoC rate cuts will continue through this year, as the current 3% base rate remains elevated and this could see another percentage point cut by year end.
“Canadian growth is low but slowly improving, the unemployment rate is near a peak, and inflation is now well within the BoC’s target range,” said RBC Economics’ Frances Donald. “Without any shocks, the central bank would likely continue to gradually ease towards, we think, 2% by year end, but in smaller magnitudes and at a slower pace than in 2024.”
The big difference with 2024 is the threat and impact of US tariffs. But the BoC’s chief noted that “Monetary policy cannot offset the economic consequences of a protracted trade conflict.” The challenge for the bank in that scenario though is the inflationary pressure of tariffs.
“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,” opined James Orlando from TD Economics. “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.”
Pimco’s Allison Boxer agrees that rate cuts will continue this year even without tariffs. “We think the Bank of Canada is more concerned of the negative growth vs. near-term inflationary impacts from any tariffs and retaliatory measures. This should open the door for further and faster cuts if there is a significant escalation going forward,” she said.
“The central bank’s decision to cut rates reflects its focus on the current state of the Canadian economy, ahead of potential external risks,” says CPA Canada’s chief economist, David-Alexandre Brassard. “The impact of potential tariffs could simultaneously dampen growth and increase inflation. It’s a delicate balancing act.”
Meanwhile, Derek Holt at Scotiabank believes that the central bank may not continue with rate cuts.
“The suite of communications [from the BoC] indicated that if extreme assumptions about tariffs are not realized, then they are probably done cutting and will let lagging effects of cuts take over,” he wrote in his reaction piece. “My take remains that we need to be open-minded around the base case scenario and how tariffs might impact developments. That's always been my point.”
