In late January, the Bank of Canada cut its key overnight lending rate, which impacts interest rates, by 25 basis points to 3%. This is the fifth straight cut since June 2024 when interest rates stood at 5%.
The modest 0.25% interest rate cut was widely expected with Canada’s annual inflation rate falling to 1.8% in December. Though that reading could be short lived; it was largely a result of the federal government’s temporary GST holiday. Even when the GST tax break ends, Canada’s inflation rate is expected to hover at around 2%.
Are More Interest Rate Cuts Coming to Combat U.S. Tariffs?
It’s not all good news. Canada’s central bank warned that should U.S. President Trump push ahead with his 25% tariff against Canadian goods, it could cause serious economic damage. It is widely anticipated that a prolonged trade war with the U.S. could send Canada’s gross domestic product reeling by 3% and trigger a recession.
Before the threat of tariffs became more evident, it was thought that the Bank of Canada’s future rate cuts in 2025 would be fewer than in 2024 and be more modest. But with a full-on trade war now expected with the U.S., the Canadian economy is set to face its most severe economic shock since the 2020 health crisis.
How Will Tariffs Impact The Canadian Economy?
The Canadian economy was projected to grow 1.8% in 2025, but a 3% trimming of Canada’s annual GDP could result in the first non-pandemic-related contraction in 16 years. As a result, consumer prices and inflation would run higher, the unemployment rate would tick up, and the Canadian dollar could weaken even further.
Economists believe the loonie could fall to as low as $0.65 U.S. with the unemployment rate jumping to an average of 7.4% in 2025.
While the Bank of Canada is not scheduled to meet again until March, a full-blown trade war could force the central bank to make an emergency meeting again to further slash interest rates to help the Canadian economy deal with the impact of a trade war.
If there is no emergency meeting, it is now widely expected that the Bank of Canada will cut interest rates at its next six meetings through to October. If those are all 25-basis-point cuts, that would take Canadian interest rates down to 1.5%. That’s a far cry from what economists were thinking in late January.
Even if Canada does meet the demands of President Trump on border security, that doesn’t mean the Canadian economy would necessarily avoid tariffs. An economist at the National Bank of Canada believes Trump’s protectionist mission could result in tariffs being lowered to 10%. This is inline with the tariffs imposed on Canadian energy products. How long those tariffs could last is open for debate.
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