- Randall Bartlett, Deputy Chief Economist • LJ Valencia, Economic Analyst
The Cuts Keep Coming as the Bank of Canada Braces for Trump’s Impact
According to the Bank of Canada (BoC)
- As was widely expected, the Bank of Canada cut the overnight policy rate for the sixth consecutive meeting, this time by 25 basis points (bps) following two 50 bps cuts in a row. Today’s cut takes the policy rate to 3.00%, the lowest it’s been since September 2022.
- At the same time, the Bank announced its “plan to complete the normalization of its balance sheet, ending quantitative tightening. The Bank will restart asset purchases in early March, beginning gradually so that its balance sheet stabilizes and then grows modestly, in line with growth in the economy.”
- In his Press Conference Opening Statement, Bank of Canada Governor Tiff Macklem had three main messages for the change in monetary policy. First, monetary policy has worked to restore price stability as evidenced by inflation remaining around 2% since last summer. Second, lower interest rates are boosting household spending, and overall economic growth is picking up as a result. Third, as the threat of US tariffs on imports from Canada is highly uncertain, it hasn’t been included in the baseline outlook. However, the Bank provided scenario analysis in the accompanying Monetary Policy Report (MPR) to address this uncertainty.
- Looking first to inflation, the Bank has revised up its baseline forecast for 2025 and 2026 modestly despite a weaker conclusion to 2024 than earlier anticipated (graph 1). This reflects both changes to the overall economic outlook and the impact of the two-month GST/HST holiday, which is weighing on inflation now but will boost it in a year’s time.
- Turning to the Bank’s real GDP growth forecast, much to our surprise, the BoC revised down its Q4 2024 tracking to 1.8% annualized from 2.0% in October (we’re currently projecting 2.5%). It’s also tracking a relatively modest 2% advance in Q1 2025 (versus our 2.3%). And without the inclusion of any tariff impacts on growth, either to the downside when they come into effect or to the upside before that occurs, the Bank is projecting relatively ho-hum growth of 1.8% in 2025 and 2026, which is somewhat higher than its potential growth forecast. Keep in mind that these forecasts were revised meaningfully lower since October (graph 2), “primarily due to a downward revision to population growth resulting from new federal immigration policies and updated assumptions related to outflows of non-permanent residents.” The Bank now expects population growth to slow to a pace of 0.5% by 2026, which is more than one full percentage point below its previous forecast. The Bank also estimates, as we do, that there is less slack in the Canadian economy than estimated back in October.
- To illustrate the risks of a possible trade war, the Bank provided three illustrative scenarios. The BoC “assumed that the United States increases tariffs on all imported goods to 25%, and its trading partners respond by increasing tariffs on imported goods from the United States to 25%.” The Bank expects the maximum drag on real GDP growth would be 3% in the first year that tariffs are applied relative to the no-tariff baseline. At the same time, the BoC anticipates the largest increase in inflation to be between 1% and 1.5% after two years, albeit in a different scenario than the one with the largest hit to real GDP. And while the Bank doesn’t outline the path for interest rates in these scenarios, we would expect it to fall to 1.50% if a trade war breaks out.
Implications
There was a lot to digest in the Bank of Canada’s January 2025 MPR. As with other economists, the BoC attempted to address the competing headwinds facing the Canadian economy. In so doing, it didn’t land far from our outlook External link., including in the various downside scenarios. But the outlook is highly uncertain, most notably because of the tariff threat coming from the United States. So, while the guidance is helpful, the future will no doubt unfold differently.
That said, given the headwinds to the Canadian economy resulting from the ongoing threat of tariffs, planned slower population growth and the impending wall of mortgage renewals, we anticipate the Bank of Canada will reduce the policy rate by another 75 bps to 2.25% before 2025 is over. But if a full-blown trade war breaks out, expect the policy rate to fall faster and further.