On June 4, the Bank of Canada held its key interest rate at 2.75% for the second consecutive time. The central bank cited “unusual uncertainty” around inflation and unknowns about trade tensions with the U.S.
Bank of Canada Governor Tiff Macklem said that U.S. tariffs continue to be the “biggest headwind” facing Canada. Macklem noted that the outlook for the Canadian economy, inflation, and interest rates will depend on what happens with tariffs.
Will The Bank of Canada Continue to Pause Its Key Interest Rate?
The rate pause was widely expected on Bay Street but the future direction is more uncertain. For now, the markets expect the Bank of Canada to announce one or two more 25-basis-point cuts in 2025. This would take the key interest rate down to a range of 2.25% to 2.5%. A more aggressive stance could be on the table.
While first-quarter gross domestic product (GDP) unexpectedly grew 2.2%, the robust gain was a result of businesses increasing their inventory ahead of tariff calls by U.S. President Donald Trump.
In April, the first month of the second quarter, Canada’s trade exports crumbled with the trade deficit soaring to record levels, as U.S. tariffs slammed demand for Canadian goods with companies pulling back and doing the opposite of what they did in the first quarter.
The big decline was across the board, with pullbacks in consumer goods (-15.4), automobiles (-17.4%), and crude oil exports (-11.7). Imports from the U.S. slumped 10.8%. Canada’s trade deficit with other countries was $10.7 billion, compared with $9 billion in March.
How Will This Impact the Canadian Economy?
The global economy is slowing, and that will have a material impact on the Canadian economy. One that is, in the words of Canadian Prime Minister Mark Carney, a “trading nation.” Canadian trade is expected to be soft over the coming months and quarters, at least until there is a clearer picture with regard to our trade relationship with the U.S.
This could force the Bank of Canada to make more than one or two interest rate cuts this year if history is any indicator. Current inflation trends are where they were in September and October 2009, when the Canadian economy was emerging from the Great Recession. Back then though, the interest rate was at 0.25%.
One big difference, however, is that we were coming out of a recession in 2009. Today, we’re yet to face any real consequences of tariffs and a trade war. Coming out of the 2020 health crisis, the Bank of Canada and other central banks were criticized for not being aggressive enough with interest rate cuts, saying higher inflation was just temporary. It wasn’t.
The Canadian economy is expected to contract in the second and third quarters. Two consecutive quarters of GDP decline is the technical definition of a recession. We won’t know of course until third-quarter economic data is announced during the fourth quarter.
To get ahead of a recession and help energize the Canadian economy though, the Bank of Canada may need to be more aggressive with interest rate cuts.
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