Bank of Canada’s Rate Cut: Relief for Borrowers, Warning for the Economy

As widely expected, the Bank of Canada cut its key overnight lending rate, which directly impacts the interest rate that banks charge, by 25 basis points to 2.25%.

This represents the second consecutive interest rate cut and totals 275 basis points, or a 2.75% reduction since the rate-cutting cycle began back in June 2024. Interest rates are also at their lowest level since July 2022.

The big question is: is the Bank of Canada done cutting interest rates or are more reductions in the cards?

What Could Happen with Canada’s Interest Rates Now?

Bank of Canada Governor Tiff Macklem gave some insight into what might happen next.

The central bank believes the current policy rate is at the right level to keep inflation close to its two-percent target while also helping the economy face a trade war with the U.S. Unlike other traditional economic headwinds, which are cyclical and somewhat predictable, a trade war with the U.S., Canada’s biggest trading partner, generates structural damage that hinders productivity and higher costs. This limits one of the goals of lower interest rates, which is to fuel demand and keep inflation lower.

This leaves the door open for another 25-basis-point interest rate cut in early 2026.

How Is the Canadian Economy Doing?

There is reason to believe this could happen. The Bank of Canada released its first base-case for the Canadian economy since the start of the year, and the outlook is decidedly downbeat. While the Bank of Canada does not believe that the Canadian economy will slip into a recession, it did say that economic growth will be weak. It blamed the guidance on uncertainties about how a trade war with the U.S., lower business investment, and slower population growth will impact the Canadian economy.

The Canadian economy contracted 1.6% in the second quarter, but the country’s gross domestic product (GDP) is expected to eke out a 0.75% gain in the back half of 2025. Growth will be fairly anemic over the next couple of years, too, with GDP projected to grow by just 1.1% in 2026 and a further 1.6% in 2027.

If we resolve a trade war with the U.S., it’s quite possible that the Bank of Canada will revise these projections upwards. But with the current U.S. administration, that’s a big “if.” Should there be a prolonged trade war, those economic projections could go down.

That is a real possibility. President Donald Trump has labelled Canada “one of the nastiest countries,” warning the country that “I can play dirtier” after a television ad sponsored by the Government of Ontario quoted former President Ronald Regan’s criticism of U.S. tariffs.

As a result, further interest-rate cuts could be justified in 2026.

How Is the TSX Doing in 2025 (and What’s Next)?

Despite these economic concerns, the Toronto Stock Exchange (TSX), Canada’s main stock market index, is continuing to have an exceptional year, up more than 20% year to date. This represents one of the best performances since 1990. The TSX is also handily outperforming the S&P 500.

The TSX topped 30,000 for the first time ever in early October, still trading near record levels. That momentum is expected to continue in 2026 and 2027, with analysts forecasting the index to exit 2026 at 43,400. Economists expect the TSX to be at 51,850 in two years.

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