
The Bank of Canada Trims 25 Basis Points in Its First Announcement of the Year
A New Year, Another Cut
- The Bank of Canada cut its target for the overnight rate to 3.0 per cent, the Bank rate to 3.25 per cent, and the deposit rate to 2.95 per cent.
- January’s Monetary Policy Report (MPR) projections are subject to heightened uncertainty due to the tariff threat by the new U.S. administration. The MPR provides a baseline forecast in the absence of new tariffs.
- In their announcement, the Bank of Canada announced it plans to complete normalization of its balance sheet, ending quantitative tightening, and will begin buying assets again in early March.
- The Bank’s MPR projects the global economy to continue growing by approximately 3.0 per cent over the next two years. U.S. growth has been revised up due to stronger consumption. China’s policy actions are bolstering near-term growth but structural challenges in the country remain. Meanwhile, Euro area growth is expected to be subdued while coping with competitiveness pressures.
- The loonie has depreciated materially against the United States dollar, largely reflecting trade uncertainty and a stronger dollar south of the border. Oil prices have been about $5 higher than what was assumed in their October MPR.
- Canada’s labour market remains soft with December’s unemployment rate at 6.7 per cent. However, job growth strengthened in the final two months of 2024.
- GDP growth in 2024 was an estimated 1.3 per cent. The Bank projects 1.8 per cent GDP growth in 2025 and 2026, slightly above potential growth and more moderate than assumed in October due to lower population growth. Excess supply will be gradually absorbed over the projection horizon.
- CPI inflation remains close to 2.0 per cent with some volatility due to the temporary GST/HST break on some consumer products. Shelter price inflation is still high but is easing gradually. A broad range of indicators suggest that underlying inflation is close to 2.0 per cent. The Bank forecasts inflation will be around 2.0 per cent over the next two years.
- A protracted trade conflict would lead to significantly weaker GDP growth and higher prices in Canada.
Key Insights
Inflation risks on the horizon. The looming threats of tariffs pose a considerable upside risk to inflation. The most immediate impact from tariffs is a weaker Canadian dollar which will cause prices on U.S. goods imported into Canada to increase. One important consideration is that the impact from tariffs will not be equal across goods as many intermediate inputs—particularly in automotive manufacturing—cross the border multiple times during production, leading to a compounding effect on prices.
Higher inflation from widespread tariffs would likely cause rate cuts to pause in the short term, with the possibility of interest rate hikes on the table if inflation gets out of control.
Resumed taxation will return the price of goods back to pre-GST/HST break levels. The federal government’s temporary GST/HST break is slated to expire on February 15, 2025. This will effectively increase prices on a number of goods and services that are exempt from the GST/HST during the tax holiday, triggering a small inflation increase in the first quarter of the year. Barring international risk factors, inflation will stabilize at the Bank’s 2.0 per cent target through much of 2025.
Further cuts to interest rates will support GDP growth. Aligning closely with the projection in today’s MPR, we forecast an improved real GDP growth rate of 1.5 per cent this year. Supporting this is lower borrowing costs from the cuts to rates which will encourage consumers to spend and businesses to invest, resulting in a steady increase in per capita real GDP through the year, a reversal of fortunes from the previous two years. While falling interest rates will give breathing room to growth, more persistent issues including weak labour productivity growth and a drastic reversal in immigration policy beginning in 2025 will be a limiting factor to growth.
For more on the potential impact of U.S. tariffs on the Canadian economy, please see our earlier insight, Trump, Tariffs and Trade.
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