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While an end to tariff uncertainty is good news for both the economy and investors, economists say it could also result in less aggressive interest rate cuts from the Bank of Canada. A growing number of economists have already recalibrated their expectations, predicting two more cuts by year-end instead of three.
Analysts say that instead of the trade war, domestic economic indicators—the mounting jobless rate, economic slack, and weaker consumer and business spending—will steer the Bank of Canada’s next rate move.
The Bank of Canada has held off on cuts twice in a row, monitoring macroeconomic developments rather than react to them. Thomas Ryan, North America economist at Capital Economics, says, “As it becomes clear the tariffs are not driving core inflation any higher or causing any second-round effects, the mounting signs of weakness in the economy (such as in the labor market, housing, and manufacturing) will push the Bank to cut rates again.” With exemptions in place, Canada’s retaliatory tariffs cover closer to C$50 billion, significantly lower than the 25% tariffs on C$155 billion worth of US imports. Ryan extrapolates that core inflation will remain around 3%.
Inflation Softening, but Core Pressures Linger
The latest CPI report showed that while headline inflation is cooling, core inflation (the Bank of Canada’s preferred measure) has remained stubbornly elevated.
These readings have reinforced the Bank’s decision to hold rates steady. Although its official mandate is to keep inflation within the 1%-3% range, it also has the flexibility to consider broader economic conditions, including the labor market, when setting policy.
This will be particularly relevant this year, according to Jack Manley, global market strategist at JP Morgan Asset Management. “I’d like to think that the Bank of Canada would be able to see through any stickiness in inflation—shelter, as the largest driver, won’t be directly impacted by interest rates,” he says. Key inflation drivers like rent and energy aren’t easily controlled by rate moves, and “if push comes to shove, the Bank of Canada should be willing to at least provide a floor for growth and a ceiling for the unemployment rate, even if it means core inflation warms a bit more than they’d like in the near term.”
There’s Path for a Cut if Data Cooperates
David Doyle, head of economics at Macquarie Group, expects inflation to moderate over the next two reports, allowing the Bank of Canada to shift focus to supporting growth. “This would increase the likelihood of a 25-basis-point cut at [the next] meeting,” he says. Still, he warns that any firmness in underlying inflation could take that option off the table.
RSM Canada economist Tu Nguyen notes that the Bank’s pause is justified, given the resilience of the Canadian economy. But she acknowledges that core inflation may ease “as aggregate demand slows with limited immigration and rising unemployment, prompting the Bank to cut rates to support growth without worrying about stoking inflation.”
Where Does Monetary Policy Go from Here?
There is another shift afoot concerning the terminal rate of the easing cycle. Any possibility of the central bank cutting rates below 2.25% (the lower end of its neutral range) is all but ruled out, as observers come around to the sense that the Bank’s monetary easing cycle may have run its course.
Nguyen expects another hold in July, adding that if core inflation remains sticky, the Bank might deliver only one more cut by year-end. That would bring the policy rate to 2.50% instead of 2.25%, as is widely projected. Although she expects the policy rate to bottom out at 2.25%, the timeline remains uncertain. “Whether the Bank gets there by late 2025 or early 2026 depends on growth rate, tariff movements and their impacts on growth and jobs, and core inflation,” she explains.
Oxford Economics’ Michael Davenport thinks the Bank of Canada would not lower rates below 2.25% “even if US-Canada tariffs are scaled back.” However, that trajectory could shift if the bank “is convinced that inflationary pressures are benign, and the economy needs stimulus, especially with major federal fiscal expansion in the pipeline,” he adds.
Given the real risks to growth looming over the economy, Manley thinks another 50 basis points of easing, from September through year-end feels reasonable. “I’d expect more clarity on trade relations by the end of the summer, and I wouldn’t be surprised if the next 50 basis points of easing happens,” he says.
Some See Room for More than Two Cuts
Though their pool is dwindling, there are still some analysts who expect policymakers to cut below the neutral range, lowering the rate to 2%. But the path there may be longer and uncertain. Thomas Ryan of Capital Economics says he still expects three more cuts, bringing the rate to 2% by year-end. However, he hedges by adding that policymakers may move slower than currently anticipated.
“Policymakers appear cautious and want to better understand the impact of tariffs first, so three cuts this year may be too optimistic,” he says. The Bank, he forecasts, “may have to delay one of these cuts until next year, when the Fed will be cutting again.”
Citi economist Veronica Clark points to softening economic indicators as a signal that the Bank of Canada could resume cutting rates as early as July 30. Slowing economic activity, she argues, implies a widening output gap, a key condition for inflation to ease.
“With slowing US growth as well and the [US] Fed likely to resume rate cuts later this year, Bank of Canada officials will likely become more forward-looking again in their decision making and will be cutting rates by July,” Clark argues, stressing that, if anything, “the economy likely requires policy rates a bit below [the Bank’s] neutral [range] in this environment.
As for 2026, JP Morgan’s Manley says it’s unlikely the Bank of Canada will reduce rates lower than 2%. “That number is awfully close to where inflation is and will likely stay, and will restrict their ‘wiggle room’ to stimulate the economy in the event of another growth shock,” he notes.
In other words, the Bank of Canada might be done after this year. If they aren’t, then cuts next year will be minimal.
Ryan says the effects of earlier rate cuts will continue to provide some support as they feed through. Further, fiscal policy will also play a role, “with the Liberal Party looking to introduce new spending or tax cuts (having already lowered the lowest marginal personal tax rate to 14% in May, from 15%,” he points out.
Global Shocks Still Lurk in the Background
For the majority of observers, the threat of tariffs has faded. Any future risk to the Bank of Canada’s rate outlook would likely stem from geopolitical events, according to Doyle. Such events “could increase economic uncertainty while also giving rise to an increase in the oil price Group,” he notes. “The Bank of Canada will be focused on the impact this could have on inflation, inflation expectations, and the output gap.”
On a reassuring note, Manley stresses that geopolitical events are inherently unpredictable and their impacts are usually transitory. “The Bank of Canada should be able to see through them when setting long-term rate strategy,” he argues.
Clark points out that it’s not the crises themselves, but their unintended consequences, such as disruption to trade flows or commodity price spikes, that could sway the Bank’s decision-making. Alluding to the ongoing conflict in the Middle East, she notes: “Higher oil prices, if anything, would keep [policymakers] somewhat more cautious on cuts due to the inflation impact.”
Domestic Weakness a More Immediate Risk
Manley remains far more concerned about Canada’s rising unemployment rate, saying it is yet to peak. “Further increases in the unemployment rate have the potential to pull forward the next rate cut,” he says. “The Bank of Canada wants more clarity on policy, but should labor conditions further deteriorate they may not want to wait any longer.”
Canadian household spending is also looking fragile. “Despite considerable policy easing, mortgage rates are still elevated relative to post-pandemic lows,” Manley says. This is “squeezing Canadian consumers and forcing them to spend less on goods and services to make their mortgage payments.” He warns that this dynamic is unlikely to improve anytime soon.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
