Economic commentary provided by Alberta Central Chief Economist Charles St-Arnaud.
Bottom line
The Bank of Canada cut its policy rate by 25bp to 2.75%, in line with our expectations.
The Statement was roughly in line with our expectations with the central bank highlighting: 1) the economy entered 2025 on a stronger footing than initially though, with both growth and the labour market being robust, 2) inflation was consistent with the inflation target but will rise, due to the end of the tax break, a weaker Canadian dollar, and higher costs due to the trade dispute 3) the extreme uncertainty act as a significant drag on growth, with businesses and households restraining their spending, and pushing costs higher.
The BoC reiterated that “monetary policy cannot offset the impacts of a trade war.” Governor Macklem made it clear during the press conference that the BoC’s primary focus going forward will be to assess the balance between the opposing impact of a trade war on inflation, with lower inflationary pressures coming from the weaker growth and the higher inflationary pressures coming from the uncertainty, weaker Canadian dollar and countertariffs.
It suggests is that BoC may look through some of the immediate upward inflationary pressures from the trade conflict, but this will depend on the persistence of these pressures and whether they lead to a rise in inflation expectations. However, with today’s communication focusing heavily on the upside risk to inflation, the appetite of the BoC to allow inflation to rise may be limited.
Overall, we believe that the general direction for interest rates is lower. However, the pace of easing is highly uncertain and will depends on US trade policies and the outlook for inflation, especially upside pressures. Nevertheless, as we wrote (see Searching for the terminal rate), lower population growth in 2025 and 2026 will be an important drag on the economy, pushing potential growth and the neutral rate lower. This means that at 2.75%, the current policy rate level will likely become restrictive later this year.
As expected, the BoC cut its policy rate by 25bp to 2.75%. However, the BoC provided little in terms of guidance on the potential direction of future interest rate decisions. This is not surprising given the conflicting impact a trade war will have on inflation, with statement saying “the focus of Governing Council will be on assessing the timing and strength of both the downward pressure on inflation from a weaker economy and the upward pressure from higher costs.” Importantly, the Bank reiterates that “Monetary policy cannot offset the impacts of a trade war.”
The BoC notes that the global environment may be slightly weaker. The Bank notes that “the US economy looks to have slowed in recent months”, while inflation remains slightly above target. Elsewhere, growth was modest in late 2024 in the Eurozone and China’s economy improved, thanks to government support. The BoC also notes that financial markets are expecting slower growth, with a fall in equity markets, lower yields and lower oil prices.
The Canadian economy entered 2025 in a solid position. The BoC notes that with growth at 2.6% in 2024Q4, Grothe “growth path is stronger than was expected at the time of the January MPR” and “past cuts to interest rates have boosted economic activity.” However, the outlook is changing rapidly as a result of the heightened uncertainty due to the trade conflict with the US. The Bank notes that the trade war is having a conflicting impact on the economy. “Recent surveys suggest a sharp drop in consumer confidence and a slowdown in business spending as companies postpone or cancel investments. The negative impact of slowing domestic demand has been partially offset by a surge in exports in advance of tariffs being imposed.”
Overall, “While economic growth has come in stronger than expected, the pervasive uncertainty created by continuously changing US tariff threats is restraining consumers’ spending intentions and businesses’ plans to hire and invest.”. This suggests that the Bank’s outlook is now weaker than in January.
Inflation remains close to the 2% target, but trade tension will push it higher. The BoC also notes that the GST holiday has lowered some prices, but that “January’s CPI was slightly firmer than expected at 1.9%”. The Bank expects inflation to rise to about 2.5% in March, as the tax break ends. The central bank also notes that its preferred measure of core inflation has remained persistently above 2%.
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Independent Opinion
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