The Bank of Canada cut its benchmark interest rate on Wednesday but signalled that it might be at the end of its easing cycle even as U.S. tariffs inflict significant and lasting damage on the Canadian economy.
The bank’s governing council voted to lower the policy rate by a quarter-percentage-point to 2.25 per cent. This was the bank’s second consecutive cut, and the fourth cut this year.
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The decision was driven by a weakening economic outlook and a belief that inflation is largely contained. But Governor Tiff Macklem suggested that it may be the bank’s last rate cut for some time.
If the economy evolves in line with the bank’s new forecast, Mr. Macklem said, “governing council sees the current policy rate at about the right level to keep inflation close to 2 per cent while helping the economy through this period of structural adjustment.”
The bank didn’t mince words about the outlook for the Canadian economy.
U.S. President Donald Trump’s protectionism and moves to dismantle continental free trade have hammered Canadian businesses and workers, and will leave lasting scars on the country’s economic capacity.
The bank estimates that Canada’s gross domestic product will be about 1.5 percentage points smaller by the end of next year than it would have been without U.S. tariffs and the uncertainty they have sowed.
“The weakness we’re seeing in the Canadian economy is more than a cyclical downturn. It is also a structural transition,” Mr. Macklem said, according to the prepared text of his remarks.
“The U.S. trade conflict has diminished Canada’s economic prospects. The structural damage caused by tariffs is reducing our productive capacity and adding costs.”
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Canada’s economy contending with steep U.S. tariffs
Since returning to the White House in January, Mr. Trump has hit Canada with a range of double-digit tariffs, both directly and as part of a push to protect certain U.S. industries.
This includes a blanket tariff on imports from Canada that don’t meet free trade agreement rules, and duties on steel, aluminum, autos and forest products.
Taken together, this has pushed the average U.S. effective tariff rate on Canadian goods to 5.9 per cent from only 0.1 per cent at the start of the year, the bank said.
The latest round of tariff negotiations between Ottawa and Washington broke down last week after Mr. Trump became angry over a TV advertisement made by the Government of Ontario that criticized tariffs.
The trade war has produced a sharp drop in Canadian exports to the U.S. and layoffs in sectors directly impacted by the levies. Even in industries not directly touched by tariffs, business investment is frozen and companies are holding off hiring, given the trade uncertainty.
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New economic forecasts see tepid GDP growth
The bank’s new base-case forecast, published Wednesday in its quarterly Monetary Policy Report, sees GDP growing by around 0.75 per cent in the second half of the year, following a 1.6 per cent drop in the second quarter.
Looking further out, the bank expects GDP to grow by a tepid 1.1 per cent in 2026 and 1.6 per cent in 2027, with trade uncertainty layered on top of a sharp slowdown in population growth as a result of Ottawa’s new immigration targets. This is the first base-case forecast the bank has published since January.
When it comes to inflation, the bank appears to be less concerned than it has been in recent quarters.
Trade disruptions continue to push up costs for businesses, but companies are having a tough time passing these costs along to customers given weak demand. Ottawa’s removal of most counter-tariffs against the U.S. in September also means there will be less of an impact on the price of imported goods.
Annual Consumer Price Index inflation was 2.4 per cent in September, with core inflation measures running around 3 per cent – the top end of the bank’s inflation-control band. But upward momentum in inflation“has dissipated,” Mr. Macklem said.
“Looking at a broader range of indicators, underlying inflation looks to be around 2.5 per cent. The bank expects inflationary pressures to ease in the months ahead and CPI inflation to remain near 2 per cent over the projection horizon,” he said.
Why might the Bank of Canada hold off on further interest rate cuts?
With the bank becoming less worried about inflation and more worried about economic weakness, it raises a key question: Why are Mr. Macklem and his team suggesting they may be done with interest rate cuts?
After all, at 2.25 per cent, the policy rate is at the lower end of what the bank considers to be a “neutral” range for its policy rate. Monetary policy is not in deeply stimulative territory.
Mr. Macklem said that the structural weakening of the Canadian economy means there is less the bank can do to stimulate growth without causing inflation.
“Monetary policy cannot undo the damage caused by tariffs. Increased trade friction with the United States means our economy will work less efficiently, with higher costs and less income. Monetary policy can help the economy adjust as long as inflation is well-controlled, but it cannot restore the economy to its pre-tariff path,” he said.
With monetary policy constrained, support for the Canadian economy is shifting to fiscal policy.
Prime Minister Mark Carney will release his first budget next Tuesday, which is expected to show significant deficit spending, with a focus on infrastructure, defence and housing.
