lower rates, higher stakes

The Bank of Canada opted to lower its policy rate again this morning, by 25 basis points, to 3.00%. This marked the sixth consecutive announcement that yielded a reduction in the Bank’s policy rate, bringing it to its lowest level since August 2022. The Bank also announced a plan to normalize its balance sheet in order to end quantitative tightening, which had been supporting bond yields and, in turn, had been imparting downward resistance on fixed mortgage rates.

In its release the Bank noted that “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”.

The once-in-a-generation spike in inflation that plagued Canada (and much of the world) for the past few years has been tamed. The headline inflation rate remained within the Bank’s target range of 1-3% for the entirety of 2024, finishing the year at 1.8%. Moreover, there is little risk ahead of a consumer-lead spike in the Consumer Price Index. The labour market remains weak with a 6.7% unemployment rate nationally, while per-capita retail spending (and per-capita GDP) has been declining.

Despite the victory over inflation that’s now been achieved—ushering in more clarity for the Bank, lenders, and borrowers, by extension—new sources of uncertainty have emerged. Of particular concern to Canada is the threat of a 25% tariff being placed on Canadian exports to the US. If this tariff is indeed implemented, and if the Canadian government responds with counter-tariffs, prices on both sides of the border will rise and demand will be reduced. Should such a scenario arise, the Bank of Canada would need to tailor monetary policy to balance the effects of increased prices (inflationary pressure) against any associated damage to the economy (deflationary or disinflationary pressure). The Bank noted in its release today that because “the scope and duration of a possible trade conflict are impossible to predict, this [Monetary Policy Report] provides a baseline forecast in the absence of new tariffs.” It later elaborates “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”. In other words, the Bank will act if and when tariffs are imposed, but not before.

The Canadian dollar has also lost some value relative to the US dollar of late (-3.5% since the US election on November 5th), in part because of the spread between interest rates in the US and Canada, in part because of the continued relative weakness of the Canadian economy, and in part because of the threats of tariffs. Among other things, a weaker Canadian dollar increases the cost of imports to Canada, which is inflationary. The Bank will factor the value of the dollar into its upcoming decisions.

The next interest rate announcement is on March 12th, and by then there may (or may not) be more clarity on whether tariffs have been, or will be, imposed by the US on Canada. With the policy rate now firmly inside the Bank’s target range, the focus will be on fine-tuning the rate and responding to the changing policy landscape.