Bank of Canada to cut interest rate amid uncertainty

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The Bank of Canada is expected to cut its policy rate by 25 basis points on Wednesday, amid widespread trade uncertainty with the United States.

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The central bank’s interest rate currently sits at 3.25 per cent, the top-line of the bank’s neutral range. In December, Bank of Canada governor Tiff Macklem said policymakers would take a more “gradual approach” to reductions of the policy rate moving forward.

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Economic data from December showed inflation dipping down to 1.8 per cent, thanks mainly to the GST/HST tax holiday introduced by the federal government. These temporary effects are expected to wear off when the measure ends mid-February, with core measures remaining more elevated the previous three months. Economic growth is tracking at 1.7 per cent for the final quarter of 2024, below the two per cent the central bank forecasted.

But Toronto-Dominion Bank deputy chief economist Derek Burleton thinks this week’s decision ultimately rests on mitigating risks associated with U.S. President Donald Trump‘s threat to impose 25-per-cent tariffs on Canadian goods as early as Feb. 1.

“Inflation’s remaining a little bit more persistent than expected, spending has been picking up, but I think ultimately the ‘Trump card’ is going to be the downside risk,” Burleton said.

Most economists believe a trade war with the U.S. would ultimately push Canada’s economy into a recession. The Bank of Canada had previously played out a scenario of 25-per-cent tariffs during Trump’s first administration. A monetary policy report from 2019, shows a 25-per-cent tariff would ultimately lead to a six per cent hit to Canada’s GDP. On Wednesday, the central bank is expected to provide updated forecasts, the first since Trump first levelled his recent tariff threat in November.

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Desjardins Group chief economist Jimmy Jean agrees that the economic uncertainty brought on by the trade risks will remain top of mind for the bank for the rest of the year.

“We expect a 25-basis-point rate cut, and that’s where the market is positioned as well,” Jean said. “I think what we might see is at a bare minimum, the language and the forward guidance likely to lean dovish.”

The path of interest rates in 2025 has become less clear with the threat of U.S. tariffs. Most banks expect three more cuts to the policy rate after Wednesday’s meeting, bringing the overnight rate down to 2.25 per cent by the end of 2025. But this could all change if Trump follows through on his threats.

“Of course, if we learn Feb. 1 that there are 25 per cent tariffs and there’s no hope that this gets pared down or targeted in some kind of capacity, we would revisit that and the bank would probably perform many more rate cuts in that context,” Jean said.

Bank of Nova Scotia economist Derek Holt warns retaliation could also mean risks to Canada’s inflation outlook, which could mean tightening the policy rate.

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“With retaliation? Now that’s a different tale and a much bigger threat over time, depending upon the form of retaliation,” Holt said in note to clients. “The outcome would strain the ability of the Bank of Canada to achieve two per cent inflation, thereby requiring incremental tightening especially with signs core inflation and wages remain hot at the margin.”

Burleton thinks the trade risks put the central bank in a difficult position, particularly as it pertains to Canada’s currency. The U.S. Federal Reserve is also making a rate decision this week, where policymakers are expected to hold rates steady.

“At the end of the day maybe they put up with some currency weakness,” Burleton said. “They just need to be a little bit careful on the interest rate front, that they’re not creating the conditions for disorderly sell off in the currency.”

He added that federal and provincial governments may be better positioned to handle the response on the economy, with “complimentary policy” from the Bank of Canada.

• Email: jgowling@postmedia.com

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