(Bloomberg) -- The Bank of Canada cut interest rates by a quarter percentage point and stopped giving guidance on any further adjustments to borrowing costs as the threat of tariffs from the Trump administration clouds the outlook.
Policymakers led by Governor Tiff Macklem lowered the benchmark overnight rate to 3% on Wednesday, the sixth consecutive cut. The move was anticipated by both markets and economists, but bonds rallied as traders absorbed the policymakers’ message: they don’t know the direction the economy is heading.
“We have a lot uncertainties out there. It just didn’t seem very useful to provide guidance,” Macklem said at a news conference. “We don’t know what the US is going to do. And even when we do know more, we’re going to have to do some more work to figure out exactly how that is going to play out through the economy.”
If there were no tariffs, economic growth in Canada would continue to pick up while inflation stays close to the the 2% target, the central bank said. “However, if broad-based and significant tariffs were imposed, the resilience of Canada’s economy would be tested,” it said in its statement.
The yield on Canada’s two-year notes slid to 2.794% as of 1 p.m. Ottawa time, the lowest intraday level since June 2022. The loonie remained down at C$1.4422 per US dollar.
The Bank of Canada has chopped its benchmark rate by two percentage points since June, a pace of easing it called “substantial.”
For now, the central bank sees inflation holding close to the 2% target well into 2026 and said the upside and downside risks to price pressures were “reasonably balanced.” Policymakers said they see evidence that rate cuts are helping to boost the economy through consumption and housing activity, and that existing excess supply in the economy would be “gradually absorbed” over the next few years.
Still, the threat of a tariff war looms large, and is “clouding the economic outlook,” the bank said. US President Donald Trump has threatened to levy 25% tariffs on goods from Canada and Mexico as soon as this Saturday, and Canada’s government has vowed to retaliate if he does.
Combined, the communications suggest the central bank isn’t likely to make further adjustments to monetary policy until the specifics of Trump’s trade policy become clearer. If that threat recedes, Canada’s economy looks to be on a path for a soft landing.
“The overnight rate stands at 3%,” Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce, said in a report to investors. “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.”
In an accompanying monetary policy report, officials produced forecasts that assumed no tariffs, but also laid out a scenario that examined how a prolonged trade dispute — in which the US and Canada impose 25% tariffs on each other — could disrupt the economy.
Overall, a trade battle would mean higher prices in Canada, even as the economy was substantially weakened, the report said. In that scenario, the inflationary effect of price increases from higher import costs and a weaker loonie would more than offset the drag from falling exports, business investment and demand.
What Bloomberg Economics Says
“The January decision and communications were somewhat more dovish than we expected as policymakers increasingly take note of trade tensions. We continue to expect further rate cuts this year — albeit at a slower pace — with a prolonged pause beginning in the third quarter.”
— Stuart Paul, US and Canada economist
Read the full report here.
In other words, a trade war would put Bank of Canada officials in a difficult spot.
“With a single instrument — our policy rate — we can’t lean against weaker output and higher inflation at the same time,” Macklem said, adding the central bank would need to “carefully assess” the downward pressure on inflation and weigh that against the upward pressure of higher input prices and supply chain disruptions.
The central bank lowered its forecast for economic growth in 2025 due to the federal government’s lower immigration targets. The bank now expects the economy to expand 1.8% in 2025 and 2026, down from previous projections of 2.1% and 2.3%, respectively. The central bank trimmed estimates for business investment and exports, but boosted its consumption forecast.
The bank estimated that interest rate divergence with the Federal Reserve was responsible for about 1% of the depreciation in the Canadian dollar since October.
“The recent depreciation we’ve seen in the Canadian dollar has been driven, in our view, by trade uncertainties and particularly President Trump’s threat to impose 25% tariffs on Canadian exports,” Macklem said.
The loonie is down about 4% against the US dollar since the US election.
Officials also announced the central bank plans to end quantitative tightening in March, when it will restart asset purchases “as part of normal balance sheet management.”
Policymakers also made changes to the deposit rate, which will now be set 5 basis points below the overnight rate as of Thursday, a move that’s likely meant to incentivize a better flow of settlement balances or reserves across financial market participants.
--With assistance from Carter Johnson, Derek Decloet and Kevin Varley.
(Updates with the governor’s comments, market reaction and other changes, beginning in the third paragraph.)
