The Canadian economy got a boost Wednesday with the decision by the Bank of Canada to cut its key policy rate by a quarter percentage point, to three per cent.
That further drop marks a sharp decline from the five per cent peak last year.
Wednesday’s news brings additional interest rate relief for users of consumer credit, mortgage holders and businesses that borrow for job-creating expansion.
The latest cut might seem modest, but it comes earlier than expected in the Bank’s rate reduction cycle.
And it still leaves the Bank with lots of firepower to continue its stimulus of the economy, which should see its key rate come down to about two per cent by year-end.
If that’s not sufficient to counter the negative impact of potential U.S. tariffs, whose size and duration we can now only guess at, the Bank is able to reduce its policy rate a great deal more.
Recall that when the Bank began raising rates to subdue inflation, in March 2022, its policy rate was a mere 0.25 per cent.
The timing of Wednesday’s rate cut is important. It is a positive sign at a time of worry over a potential trade war between Canada and the U.S. that would raise costs in both countries.
Canadians are already enduring a cost-of-living crisis.
If the U.S. imposes a 25 per cent tariff on all imports from Canada and Mexico, as U.S. President Donald Trump threatens to do by Feb. 1, and if Canada retaliates with its own tariffs on U.S. imports, as is likely, the Canadian economy could shrink by as much as six per cent, causing a recession.
Recent polling by Pollara Strategic Insights shows that about 70 per cent of Canadians believe we are already in recession.
Yet most economists expect U.S. tariffs would be applied to only certain Canadian exports. And they believe the duration of the tariffs might be relatively short if negotiations between the two countries are successful in lifting the tariffs.
The economy has already benefited from the Bank’s rate cuts to date.
As interest rates have dropped, “We’ve started to see a greater willingness (of consumers) to spend, whether it be going out to restaurants, paying for services or buying physical goods,” says economist James Orlando of TD Economics.
In a Jan. 24 report, the Conference Board of Canada forecasts economic growth of 1.5 per cent this year and 1.9 per cent in 2026, despite the tariff threat.
This week, leading real estate consultancy CBRE reported a 2024 recovery in the Canadian retail sector, including the Toronto market, where retail spending has strengthened, and quality retail space is now in short supply.
But negative popular sentiment can be a self-fulfilling prophecy.
So, it’s important that the Bank acted Wednesday to reassure consumers and businesses that borrowing costs remain on a downward trajectory.
Without saying as much, the Bank has enlisted in the “Team Canada” response to the U.S. tariff threat.
Team Canada’s widely reported lack of unity should not be exaggerated.
Ottawa and the provinces are setting aside tens of billions of dollars to fund support payments to protect Canadians from harms the tariffs might do.
That includes support for industry.
On Tuesday, Guelph, Ont.’s Linamar, the major auto parts maker, announced a $1.1-billion expansion of its Ontario operations with about $270 million in federal and Ontario government support.
That investment is expected to protect almost 10,000 existing jobs and create more than 2,300 new ones.
And the provinces have agreed to consider knocking down the internal trade barriers that depress GDP by an estimated four per cent per year.
But U.S. tariffs would hurt, with approximately 46,000 companies in Canada dependent on exporting to the U.S.
Those exports support an estimated two million Canadian jobs.
If Canada retaliates with its own tariffs on U.S. imports, as it did against U.S. tariffs imposed by Trump’s first presidential administration, Canadians can expect a price shock as the cost of U.S. imports rises.
To prevent a resulting uptick in inflation, the Bank would try to convince Canadians that an inflationary trade war with the U.S. is temporary.
That could be a tough sell.
The last time monetary authorities in Canada and the U.S. told us that rising inflation was “transitory,” in 2021, abnormally high inflation lasted for more than two years.
But that bout of historically high inflation had multiple causes beyond anyone’s control, including the release of post-pandemic pent-up demand and an overstressed global supply chain.
By contrast, a resurgence in inflation this year would be politically driven, originating in the White House.
In other words, Inflation 2.0, if it occurs, more readily lends itself to comparatively prompt political solutions than the hyper-inflation of 2021-2023.
Of course, it could be avoided altogether if Trump wasn’t so enamored of protectionism, a relic of the economic Stone Age that will benefit no one.
