The Bank of Canada will be weighing the threat of potential U.S. tariffs slowing the economy versus rising inflation concerns at its interest rate decision next Wednesday — but a rate cut remains solidly on the table.
As of Wednesday morning, markets were pricing in an 83-per-cent chance of the central bank reducing the key rate by a quarter percentage point, according to data provided by the London Stock Exchange Group (LSEG).
Several economists are also expecting the move, which would lower the interest rate to three per cent from 3.25 per cent.
The forecast is supported by the central bank’s cautious message in December, when it suggested it would slow the pace of cuts going forward after reducing the key rate by 50-basis-points twice in a row.
At that meeting, Bank of Canada governor Tiff Macklem said that U.S. President Donald Trump’s proposed tariffs — which could land as soon as Feb. 1 — were a “major new source of uncertainty” for prices in the new year.
If Trump imposes 25 per cent tariffs on all Canadian imports, it could be devastating to the Canadian economy and trigger a recession.
“Were it not for the threat of U.S. tariffs hanging over the economy, it would be easy for the Bank of Canada to justify a pause at its meeting next week,” Stephen Brown, economist at Capital Economics, wrote in a research note.
“Nonetheless, it still seems likely that the bank will cut by 25 basis points again next week,” Brown added. “Even if President Donald Trump does not follow through with his most recent threat to impose a 25-per-cent tariff on Canada on Feb. 1, that rhetoric will hit business and consumer confidence and suggests that the economy would still benefit from additional monetary support.”
Trump’s tariffs will likely have uneven impacts on individual Canadian provinces depending on the levied size, duration and industry coverage, according to research by BMO Capital Markets.
Ontario is among the provinces most exposed to the tariff threat as U.S. goods exports top 17 per cent of provincial gross domestic product (GDP), spanning across a range of industries, including autos, machinery, and consumer goods. Overall, U.S. exports account for 18.7 per cent of national GDP.
Complicating central bankers’ decision on Wednesday are signs of rising inflation. Despite inflation in December falling to 1.8 per cent — below the bank’s target of two per cent — part of the decline was attributed by Statistics Canada to the GST holiday, as food and alcoholic beverages sold at restaurants and stores contributed most to the slowdown in prices.
In fact, the Bank of Canada’s preferred “core inflation” measures, which adjust for tax changes and other volatile items, rose on average over the past three months, suggesting that inflation readings are likely to move up in the months ahead, TD economist Leslie Preston wrote in a note to clients.
And, if Canada decides to slap retaliatory tariffs on the U.S., it could end up raising prices for Canadian consumers.
Still, unemployment has been trending higher, despite dropping slightly to 6.7 per cent in December, pointing to a weaker economic outlook.
TD’s economists are expecting the central bank to cut interest rates by a quarter percentage point at every other decision in 2025 starting next week.
Andrew DiCapua, economist at the Canadian Chamber of Commerce, says the bank is in a difficult spot.
“The potential for new tariffs and retaliatory actions will reverse progress on inflation and growth — a tough situation for any central bank.”
DiCapua said that a pause in rate cuts was possible, but not likely as rates are constraining the economy.
“The Bank has shown its willingness to move aggressively, like cutting rates by 50 (basis) points, so if they do hold off in January, they might have to move in a big way (at following meetings) depending on how things develop.”
