The Bank of Canada’s 25-basis-point interest rate cut may have been expected, but uncertainty is building around its next move, since US President Donald Trump may impose huge tariffs on Canadian goods. While a full-on trade war isn’t the base case for most economists, tariffs could hit the Canadian economy hard and trigger more aggressive rate cuts. Canada already faces a raft of economic headwinds: higher unemployment, dampened business spending, and still-restrictive interest rates.
The Bank of Canada’s January Monetary Policy Report, released concurrently with the rate announcement, stresses that any future monetary policy moves “are subject to more-than-usual uncertainty because of the rapidly evolving policy landscape, particularly the threat of trade tariffs by the new administration in the United States.”
The central bank’s sixth consecutive rate cut (its first in 2025) brought the overnight interest rate from its height of 5.00% in 2024 to 3.00%, a touch below the top end of its neutral range of 2.25%-3.25% (wherein rates neither stall nor stimulate economic growth).
Market observers are anxiously focused on Feb. 1, when Trump is expected to announce a punitive 25% tariff on all Canadian goods shipped south of the border. The following insights come from market analyst notes to clients and responses to Morningstar’s request for comments on the Bank of Canada’s rate decision.
Nick Rees, senior FX market analyst at Monex Canada
“Lower interest rates, and therefore borrowing costs, should bring some relief for Canadian businesses faced with potential tariff risks. That said, to fully offset the impact of a 25% tariff on Canadian exports, we think much more easing would be necessary than the Bank of Canada is willing to admit at present, at least based on today’s statements. The devil will of course be in the detail. And given the erratic nature of Trump’s policymaking so far, we are awaiting the weekend with bated breath, as are many in markets.”
Jules Boudreau, senior economist at Mackenzie Investments
“At 3%, in our view rates are still too high to propel the Canadian economy out of its prolonged slump, but the Bank has clearly decided that it is approaching appropriate territory.
“While the rate change was not a surprise, the policy statement and Monetary Policy Report contained two striking surprises. First, the Bank of Canada is ending its quantitative tightening program, six months earlier than we had expected. Our view is that quantitative tightening was not significantly slowing the Canadian economy. But the Bank of Canada might see the end of QT—and restarting of asset purchases—as substituting for a rate cut or two, giving them cover to stop cutting rates earlier.
“The long-awaited tariff scenario analysis in the Monetary Policy Report posits a significant rise in inflation. The 1.6 percentage point increase in inflation over three years in the 25% tariff scenario is larger than we expected. But most strikingly, it is spread out over a very long period, with the brunt of the price increases getting felt in the third year following the tariffs. This suggests that the Bank of Canada could push back against price increases by hiking in the face of tariffs, rather than cutting rates to cushion the blow to growth and employment. [However], we still believe that, ultimately, tariffs imply lower long-term rates in Canada, with the Bank of Canada needing to bring rates below 2% in 2026. But it might take more time to get there.”
James Orlando, director and senior economist at TD Bank
“The bank noted ‘more-than-usual uncertainty’ surrounding its outlook due to the threat of trade tariffs. Although no specific tariff assumption was included within their forecast, it does recognize the threat has an impact on financial markets and business decisions. The bank is forecasting solid economic growth, averaging 1.8% in 2025 and 2026, while core inflation is forecasted to reach 2.1% by end-2025.“In explaining why the Bank of Canada decided to slow the pace of cuts, it highlighted the cumulative reduction in the policy rate since June, which has boosted consumer spending and housing. This means the economy requires less monetary support from the central bank.
“The economic outlook has become highly uncertain with Donald Trump threatening to make an announcement on tariffs this Saturday. Canada exports C$1.9 billion daily in goods and services south of the border. This sums to around 20% of Canada’s economy, with nearly two million jobs dependent on US trade. We are still hopeful that tariff threats are more of a negotiation tactic, meaning they would be temporary and carry less long-term impacts. Yet, this is a tail risk that remains front and center in the mind of the Bank of Canada. Our baseline forecast remains that the Bank of Canada will cut rates to 2.25% by year-end, but should 25% tariffs come into play for more than a few months, we’d expect the central bank to cut more aggressively in order to cushion the economy.”
Royce Mendes, managing director and head of macro strategy at Desjardins Capital Markets
“The Bank of Canada cut rates another quarter-point, taking the policy rate to 3.00%, but officials were hesitant to commit to anything more. The accompanying communique pointed out that the substantial easing conducted to date was having its desired stimulative effect on the Canadian economy. Importantly, the Bank of Canada now judges the risks to inflation as roughly balanced around the 2% target. As a result, in the event that no tariffs are implemented between now and the next rate announcement, it’s likely that central bankers take at least a brief pause in March. That being said, the threat of a trade war with the US is very real. Given that the Bank of Canada’s base case projections don’t include any tariffs, it’s more telling to look at the scenario analysis provided when judging where rates are headed.
“The central bank’s estimates for growth and inflation in a full-blown trade war with the US suggest that there’s scope for significant easing ahead. It’s fairly clear that the Bank of Canada expects the economy will fall into recession if the US raises 25% tariffs on all imports from Canada. Given that officials assume that Canada retaliates and the currency depreciates, a temporary increase in inflation results. However, the magnitude of that acceleration in price growth shouldn’t be enough to stop the central bank from responding to the economic weakness with lower interest rates. As we said, in our preview note, easier monetary policy isn’t a cure for a trade war, but it can help the economy adjust.
“Our forecast is that the Bank of Canada will cut the policy rate down to about 1.50% if a trade war breaks out. That’s less than the typical 300-400 basis points of easing necessary to revive the economy from a recession. While we think Canadian officials can largely look through any trade war-induced inflation, they can’t completely ignore it. As a result, the economic recovery from lasting tariffs should be expected to be less V-shaped than typical. Note that if the tariff threat is watered down to something closer to 10% with some exceptions, we still expect the policy rate to decline to 2.25% by the end of the year given weakness in the domestic economy.”
Tu Nguyen, economist at RSM Canada
“The cut is needed for economic expansion to pick up, as price stability has been restored and amidst the uncertainty fueled by threats of trade tariffs. Inflation expectations have also returned to historical norms.
“The Canadian economy saw an increase in activity after two large consecutive cuts last year. However, consumers and businesses are still holding back on spending and investments while anticipating further cuts.
“Looking ahead, we expect two more 25-basis-point cuts to bring the policy rate to neutral at 2.5% by the end of this year. At the same time, trade policy uncertainty clouds Canada’s economic outlook and makes the rate path uncertain. If tariffs were implemented and retaliation from the Canadian government took place, the Bank would face a challenging task. Tariffs could raise prices, which would prompt rate hikes. But aggregate demand would weaken, which would prompt rate cuts.
“If there were no tariffs imposed on Feb. 1, the next date to look out for is April 01, when the report on US trade balances is due. As of now, the Bank of Canada makes decisions one rate announcement at a time, based on information that is available rather than uncertain threats.”
Douglas Porter, chief economist at BMO Economics
“The move was as expected and cements the Bank’s title of most aggressive cutter in the world. The Bank had some other key messages beyond the tariff threat, as it also highlighted that inflation is expected to stay close to target and that domestic demand is indeed turning the corner. The modest downward revision in GDP growth for both this year and next is put down to the much slower population growth projection now in train—although we would note that the range of potential growth was somehow unaffected by this development in their view. The Bank also pointed out that the labor market, while soft, has seen some improvement too. Wage growth is showing signs of slowing. Business investment continues to be a soft spot (and could be truly rattled by a trade war).
“Looking ahead, the entire discussion was, appropriately, dominated by the threat of US tariffs. The Bank’s economic forecast did not take tariffs into account (which has been our convention as well), citing the profound uncertainty around the timing, scope, and duration of any tariffs. However, it did lay out a detailed scenario of how broad 25% tariffs would affect the economy; the key points there are an expected 2.5% hit to real GDP in the first year, but also some net upside on inflation (reflecting full retaliation and a much weaker Canadian dollar).
“Today’s steps by the Bank of Canada can be viewed as battening down the hatches ahead of a possible trade war storm. As noted, the 200 basis points of cumulative rate cuts are setting a much more positive backdrop for the Canadian economy—arguably one of the most rate-sensitive economies in the world. The next steps clearly depend on what unfolds on the trade front. We suspect while the Bank may initially respond cautiously to a trade war, eventually it would be compelled to cut much more than the market currently expects.”
Avery Shenfeld, senior economist at CIBC Economics
“The Bank of Canada isn’t certain about what comes next, but then again, who is? After delivering an as-expected quarter-point cut, the overnight rate stands at 3%. Even without the risk of a trade war, that in itself would imply some caution, because nobody can be too sure about where the neutral rate lies, and how low rates have to go to deliver still-needed stimulus.
“The statement noted the pick up in growth in [2024] Q4, and spurred by lower interest rates, projects growth to be above potential in the next two years, although that call would include the impact of any further easing in monetary policy. While growth was revised downward by a few decimal places over the forecast horizon, that matched a lower path for potential output tied to upward revisions to historical growth, and a downward revision to population growth ahead. Our judgement is that rates, including 5-year mortgages, are still too high to deliver the necessary lift, including the Bank’s projection for strength in residential construction.
“The combination of a labor market that the Bank describes as ‘soft’ and underlying inflation judged to be near 2% tilts the policy balance towards a further 75 basis points in cuts in our forecast, particularly as the tariff threat weighs on confidence. On tariffs, the Bank is in the throes of a major research effort, but seems to believe, as we do, that a trade war would have only a temporary lift to inflation, but could entail a material hit to growth that wasn’t factored into their forecasts.”
Rachel Siu, head of Canadian fixed income strategy at BlackRock.
“The [Bank of Canada] statement pointed to continued progress on inflation, with CPI measures remaining in the 2% target range, and an improvement in economic growth, noting a pickup in consumer spending and housing activity, supported by the impact of prior monetary easing.
“The Bank’s baseline forecasts do not incorporate the impact of potential US tariffs, due to the wide range of possible outcomes. In our view (and as acknowledged by the Bank), the rate path forward remains highly uncertain and dependent on the scope and magnitude of potential tariffs implemented by the US.”
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