After five straight interest rate cuts in 2024, economists say the Bank of Canada is likely to keep trimming in 2025.
But by how much? That might depend on how much you believe Donald J. Trump.
The U.S. president-elect’s threat to impose a 25 per cent tariff on all Canadian imports would be a devastating blow to an already-sputtering Canadian economy if he follows through. And that could prompt the bank to keep up its campaign of rate cuts in an effort to give the economy some life.
“Trade wars are bad for open economies that depend on trade,” says Shaun Osborne, chief currency strategist at Scotiabank. “And we’re one of them.”
The Bank of Canada’s key overnight rate was cut five times in 2024, from five per cent to its current 3.25 per cent.
The bank raised interest rates 10 times between March 2022 and last summer in a bid to wrestle inflation down to its two per cent target. Inflation peaked at 8.1 per cent in June 2022, as the Canadian economy opened up from COVID-related restrictions.
In November, Canada’s annual rate of inflation was at 1.9 per cent, just below the middle of the bank’s one to three per cent target range.
The theory is that by making it more expensive to borrow money, consumers and businesses will spend less, driving down prices and slowing the economy.
Now, as the economy slows and inflation has been heading mostly downward, the bank is taking the reverse approach, trying to stimulate growth by cutting rates.
The bank supersized its last two rate cuts, dropping 50 basis points — a full half percentage point — twice in a row.
Trading on the overnight interest swaps market is pricing in a 50 per cent chance of a 25-point cut at the bank’s next decision day Jan. 29, and is predicting a total of 50 points in cuts by the end of 2025.
But some observers are predicting even more cuts as the bank tries to spark the economy, with the threat of tariffs making the task even more urgent.
At BMO, the official forecast is for 75 points of cuts in 2025, which would bring the overnight rate down to 2.5 per cent. But if tariffs get implemented in their threatened form, deeper cuts will be necessary, says BMO chief economist Douglas Porter.
“As the Bank (of Canada) notes, the major wildcard is what unfolds on the tariff front, and how Canada responds; suffice it to say, rates are going lower still if broad U.S. tariffs are imposed on Canada,” Porter wrote in a research note after the Bank of Canada’s last meeting in December.
Even the threat of the tariffs is weighing on the Canadian economy, argued CIBC chief economist Avery Shenfeld.
“That uncertainty will weigh on business investment,” Shenfeld says, “even if the tariffs never arrive, but could entail a major hit to exports if actually delivered.”
CIBC’s official forecast is calling for a full percentage point of cuts, bringing the overnight rate down to 2.25 per cent.
At RBC, forecasters are predicting even deeper cuts, with the overnight rate coming down by 1.25 percentage points to sit at two per cent by July next year.
An already-struggling economy will be hit by a drop in immigration, as well as the potential for tariffs, RBC economists wrote in a report.
While the RBC economists argue that the threat of 25 per cent tariffs is likelier a negotiating stance than a statement of what will actually happen, the continued potential for trade uncertainty will still take a toll, they said.
This, however, won’t be the last time that tariffs are used as negotiating levers, and there is a risk of targeted measures on specific products and industries like the 2018 tariffs on Canadian steel and aluminum products,” the RBC economists wrote.
Even Bank of Canada governor Tiff Macklem has acknowledged the uncertain outlook, thanks to the prospect of tariffs.
“The reality is we don’t know if those tariffs will be implemented, we don’t know what exemptions there may be, we don’t know if Canada will retaliate,” Macklem said after the Bank’s most recent rate announcement. “All those things are very important to what could happen to the Canadian economy. Even the uncertainty will hold back investment decisions and so it is probably already having some effect.”
Still, if the tariffs are implemented as threatened, Macklem said economies on both sides of the border would be hurt.
“There’s no question that if tariffs at this level did go through then they would be very disruptive to the Canadian and U.S. economies,” Macklem said.
