The Bank of Canada cut its benchmark interest rate by a quarter-point on Wednesday, lowering borrowing costs for the first time since March as U.S. tariffs continue to batter the Canadian economy.
As widely expected, the bank’s governing council voted to lower the policy rate to 2.5 per cent from 2.75 per cent. This follows three consecutive rate decisions where the central bank remained on hold.
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The bank has been reluctant to ease monetary policy amid a trade war with the United States, given the possibility that U.S. tariffs and Canadian counter-tariffs could push up consumer prices and reignite inflation. But that calculus has shifted as unemployment has risen, exports have plummeted and inflation has remained relatively benign.
“Considerable uncertainty remains. But with a weaker economy and less upside risk to inflation, governing council judged that a reduction in the policy rate was appropriate to better balance the risks going forward,” Bank of Canada Governor Tiff Macklem said in a press conference after the announcement.
Mr. Macklem said there was a “clear consensus” for a cut on Wednesday. But he gave few hints about where interest rates will go from here, saying that the bank would “look over a shorter horizon than usual, and be ready to respond to new information.”
The rate cut is happening against a weak economic backdrop. U.S. President Donald Trump’s tariffs have hammered Canadian exports, which fell 27 per cent in the second quarter as tariff front-running went into reverse and U.S. demand dropped. That drove a 1.6 per cent annualized contraction in Canadian real gross domestic product in the second quarter.
“Tariffs are having a profound effect on several key sectors, including the auto, steel and aluminum industries. Chinese tariffs on canola, pork and seafood, new U.S. tariffs on copper, and higher U.S. tariffs on softwood lumber will spread the direct impacts further,” Mr. Macklem said.
The labour market weakened significantly over the summer, particularly in tariff-exposed industries and among young people. The unemployment rate hit 7.1 per cent in August, the highest level since 2016 outside the pandemic.
Business investment is likewise weak. And while consumer spending has held up fairly well, Mr. Macklem warned that slow population growth and rising unemployment will likely weigh on household spending in the coming months.
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The bank’s reluctance to lower interest rates through much of 2025 was based on concerns about sticky core inflation measures, which have remained stubbornly above the bank’s 2-per-cent target. It was also nervous that tariffs and supply chain disruptions would add to inflation even as they hurt economic activity – a tricky combination for a central bank to manage.
Core inflation measures have remained around 3 per cent, but Mr. Macklem did not sound particularly concerned about price pressures on Wednesday. He said that a broad range of indicators suggested that underlying inflation was likely running at around 2.5 per cent.
“Although there are still some mixed signals, on balance, recent data suggest the upward pressures on underlying inflation have diminished,” Mr. Macklem said.
Prime Minister Mark Carney’s decision in August to drop retaliatory tariffs on more than $40-billion worth of U.S. goods – products that comply with continental free trade agreement rules of origin – also means there will be less upward pressure on imported goods prices, Mr. Macklem said.
The central bank gave no guidance about its plans for the Oct. 29 rate decision, or where interest rates might go from here.
Financial markets now put the odds of another quarter-point rate cut in October at around 40 per cent, according to LSEG data. Only one more rate cut is fully priced in over the next year.
A number of Bay Street economists, however, expect the bank to follow up with another cut next month.
“Given the clear consensus within Governing Council around the deteriorating outlook, we see a very high bar to pause next month,” Toronto-Dominion Bank strategists Robert Both, Andrew Kelvin, Emma Lawrence and Jayati Bharadwaj wrote in a client note.
“The fact that Governing Council is still assessing risks over a shorter horizon than usual does suggest a bit more uncertainty around next month’s meeting than we’d otherwise expect, but we think pausing in October would require a material reversal in both the economic data and the sentiment around Canada-US trade.”
A lot will depend on what happens on the trade front. So far, Mr. Carney has failed to secure a deal with Mr. Trump that would remove or lower tariffs. He has said he is now trying to secure “small” sectoral deals that would lower tariffs on steel, aluminum, autos and lumber, rather than a grand bargain that would deal with all tariffs.
The government is also shifting focus to the upcoming review of the United States-Mexico-Canada Agreement, the free trade pact that is currently protecting around 85 per cent of Canadian exports to the U.S. from tariffs.
Mr. Macklem said that monetary policy is a blunt tool that can’t do much to repair the damage U.S. tariffs are causing to specific industries. Targeted fiscal support measures are a better tool for that, he said.
But monetary policy can help cushion the blow to the overall economy, he said, and the bank would be paying close attention to how trade disruptions are feeding through to other sectors and impacting prices.
“We are paying close attention to how exports evolve given the impact of U.S. tariffs and changing trade relationships; how much this spills over into business investment, employment and household spending; how the cost effects of trade disruptions and reconfigured supply chains are passed on to consumer prices; and how inflation expectations evolve,” Mr. Macklem said.
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Wednesday’s rate cut will lower interest-rates for variable-rate mortgages. What happens to fixed-rate mortgages will depend on what happens in the bond market.
That will be influenced as much by what happens in the United States as in Canada. On Wednesday afternoon, the U.S. Federal Reserve will announce its own rate decision. Markets are expecting a quarter-point cut, and analysts will be watching to see what the Fed signals about future rate cuts in its quarterly summary of economic projections.
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