We’re days away from another Bank of Canada interest rate announcement — the first of eight scheduled for 2025 — and though economists were pretty much set on a 25 basis-point cut before breaking for the holidays in December, the economic climate has been turbulent enough to spur a fresh wave of speculation.
The variable that’s on everyone’s lips is (recently re-minted) US President Trump’s continued threat of a 25% tariff on all Canadian (and Mexican) goods, which could go into effect as soon as February 1st. Beyond the economic uncertainty that looms as a result of that, there’s also the mixed bag of economic indicators like consumer spending, job data, and inflation. So all in all, the central bank’s next decision — slated for Wednesday, January 29 — is no so cut and dried.
Before we get into what economists with Canada’s ‘Big Five’ banks are speculating for the policy rate (this month, and later in 2025) with these curveballs and the latest data releases in mind, a quick recap of 2024: Across eight announcements, the Bank lowered the rate five times, including by 50 basis points, back to back, in October and December. We will go into this next decision with a policy rate of 3.25%, which is the lowest it’s been in over two years.
Economists with TD haven’t changed their tune since December, and continue to call for cut of 25 bps this week, which would bring the central rate down to a tidy 3%. This was reiterated in a January 21 analysis of Statistic Canada’s latest Consumer Price Index print from Economist Leslie Preston, who says that “December's inflation data came in line with the Bank of Canada's expectations for inflation to average close to 2%.”
As Preston was getting at, StatCan reported that headline CPI rose by 1.8% year over year in December, down from 1.9% in November. But, as we now know all too well, the BoC isn’t all that fussed with the headline metric; instead, they put weight in core inflation, which clocked in at 2.5% (year over year) last month, swinging above the BoC’s desired target for the measure.
“Despite the tax cut driven dip in headline inflation, core inflation pressures have picked up over the past three months, suggesting that inflation readings are likely to move up a bit in the months ahead,” Preston writes. “This will give the Bank of Canada reason to adopt a more gradual pace of interest rate cuts this year. We expect a quarter-point cut at every other decision in 2025.”
A more recent January 24 publication from Economist Maria Solovieva that takes into account not just inflation, but also the latest retail sales data and Trump’s tariffs threat, reiterates TD’s call for a quarter-point cut this week. It additionally underscores that all eyes will be on the Bank’s accompanying Monetary Policy Report “for insights into how the Bank is incorporating trade risks to its outlook.”
Over at RBC, the expectation is for the BoC to opt for “a more gradual 25 basis-point pace” this week, according to January 24 note from economists Nathan Janzen and Claire Fan. In turn, the Bank would be “widening a gap with U.S. policy rates as the Federal Reserve is widely expected to forego a January rate cut.”
“A weak Canadian economy has prompted earlier and more aggressive interest rate cuts from the BoC compared to other advanced economy central banks,” they add. “But the 3.25% current overnight rate is still at the top end of the BoC’s 2.25% to 3.25% estimated range for “neutral,” which would not put upward or downward pressure on growth or inflation over time. It is also well above the 1.75% peak rate in the decade before the global pandemic.
Speaking to what the BoC will consider in future deliberations, Janzen and Fan acknowledge that recent gross domestic product growth and inflation data “have been mixed,” but that “labour markets are still soft enough to argue that more interest rate cuts are needed for the economy to rebound enough to prevent inflation from undershooting the 2% target.” As such, RBC’s expectation is that Canada’s central bank will end up cutting the policy interest rate to “a slightly stimulative 2%” across 2025.
But again, long-term, there is the uncertainty of potential “tariff shock” — something that’s discussed, at length, by Janzen, alongside RBC’s Frances Donald, in a separate report, published on January 22.
“[Tariffs] tend to increase costs (inflationary), but they also weaken an economy (deflationary). Most central banks have been clear that they are less likely to respond to inflation directly generated from tariffs, because they increase the price once, and then no longer contribute to year-over-year inflationary pressures,” they write. “However, the follow on impact of rising inflation driven by a drop in demand could be more damaging. How the Bank of Canada will respond to this environment is not clear, but it has implications for other sectors like housing that could provide an offset from further interest rate cuts.”
CIBC Economist Andrew Grantham writes in a new report that the BoC has a balancing act on its hands. “We think that the green shoots of an economic acceleration are small enough, and the storm clouds from potential tariffs dark enough, to justify a further 25 bps interest rate cut,” he says.
In terms of “green shoots,” Grantham points to December’s labour force survey as the “tallest” of the bunch — though he cautions that “if population growth was really much slower, the gain in employment may have been a less impressive 40,000 or so” (as opposed to the 91,000 gain we ended up seeing).
“Elsewhere, we have also seen some green shoots of improvement in retail sales volumes and housing sales, which suggests that past interest rate cuts are starting to help growth,” he went on to say. “However, in per capita terms the level of activity remains quite low, suggesting plenty of room for further growth before we should start worrying too much about inflationary pressures.”
And that’s all to say that there was a strong case to be made for a quarter-point rate cut this week, and according to Grantham, Trump’s tariff threat only makes that case stronger. “While tariffs, and likely retaliatory actions, would boost the price level in the near term, our analysis suggests that the impact on activity (adding to the slack already present within the economy) would be great enough to be disinflationary over the medium term without additional policy support,” he says.
Although Economists with BMO aren’t arguing with the ‘wide consensus’ that the BoC will trim its policy rate by a quarter-point to 3% on Wednesday, they point out that there are reasonable arguments against cutting at all — reasonable, if not for the threat of Trump’s tariffs.
“If these were normal times, we would be calling for the Bank to stand aside,” writes Economist Douglas Porter in a note from Friday. “With the Fed on hold, the Canadian dollar on its heels, core inflation turning back up, and plenty of signs of life in domestic spending, there are reasons to take a pause. This week’s other major economic release revealed that after a flat November reading, retail sales jumped 1.6% last month (juiced by the GST holiday, and a late Black Friday).”
But “these are clearly not normal times,” Porter goes on to say. “With the Canadian economy facing a possible massive shock from U.S. tariffs, the Bank should likely be cutting simply from a risk-management perspective. Even if the tariff threat is hollow — which may indeed be the case — the now deep uncertainty of US/Canada trade relations will likely put an icy chill into business capital spending plans, at least for any firm that exports.”
In a more recent note, published on January 27 (today), Economist Benjamin Reitzes doubled down on BMO’s call for a 25-bps cut this week, while also acknowledging that recent economic data does “skew a bit more toward a pause.” Meanwhile, longer-term, economists with BMO are now calling for the policy rate to be brought down to 2.5% by this fall.
As he did leading up to the last interest rate announcement on December 11, Scotiabank Economist Derek Holt continues to express his aversion to rate cuts, writing in a January 24 report that the BoC will “probably” cut by 25 bps this week — “it would be the easy thing to do given it is priced” — but that he “wouldn’t.”
Though a quarter-point cut would be “consistent” with BoC Governor Tiff Macklem’s messaging at last month’s press conference that Council will be taking a “more gradual approach” to monetary policy moving forward, Holt points to “uncertainty around the tariff issue” as one of the reasons why he would recommend a rate hold this time around. “[…] also because the BoC’s core measures of inflation are too hot to merit adding to the 175bps of easing to date (here), the job market is strong and no it’s not just the public sector (here), and the consumer is responding to rate cuts (here),” he went on to say.
“Most of the consumption growth in Canada is coming from services that comprise 57% of total consumer spending and autos. Prior arguments about pent-up demand, the lagging effects of immigration into housing markets, massive hoarding of household net worth above trend line projections across all income quintiles, solid job markets, fiscal stimulus and easier mortgage rules all still hold.”
In the same report, Holt warns that Trump’s tariffs, if realized, could incite rate hikes down the line. To back this up, he references the July 2019 Monetary Policy Report published the last time Trump sparked speculation of tariffs. That report warned that inflation could drift higher (and persist higher for longer) under a 25% tariff scenario, combined with a weaker Canadian dollar and lower productivity. “This pressure is only partially offset by weaker aggregate demand,” it also noted.
While the 2019 report doesn’t get into how the policy rate would respond in this turn of events, Holt surmises that the inflationary pressure could prevent the BoC from further easing. “It may — and probably would — come to drive further policy tightening,” he adds.
