Bank of Canada Senior Deputy Governor Carolyn Rogers looks on as Governor Tiff Macklem speaks during a news conference on Dec. 11 in Ottawa.Adrian Wyld/The Canadian Press
The Bank of Canada cut its key interest rate by half a percentage point on Wednesday and signalled that it will slow the pace of rate cuts going forward as the Canadian economy enters a period of heightened uncertainty around population growth and the threat of tariffs.
As widely expected, the bank’s governing council lowered the policy rate to 3.25 per cent from 3.75 per cent. This was the fifth consecutive rate cut since June and the second oversized move in a row.
With inflation back at the central bank’s 2-per-cent target, policy makers have moved quickly to bring borrowing costs down to a less restrictive level to avoid a recession and offer some relief to homeowners with mortgages and other borrowers. Now, having cut rapidly since the summer, the bank appears to be entering a slower, more methodical phase of the easing cycle.
“With the policy rate now substantially lower, we anticipate a more gradual approach to monetary policy if the economy evolves broadly as expected,” Governor Tiff Macklem said in a press conference after the announcement.
He said that further rate cuts are possible, but would likely happen at a slower pace. “We’re going to take our decisions one meeting at a time based on the best available information,” he said.
Markets and economists react to Bank of Canada decision
While financial markets were anticipating the oversized move, back-to-back half-point cuts are unusual. Excluding crises, such as the start of the COVID-19 pandemic, the central bank last delivered two half-point cuts in a row in 2009.
Mr. Macklem justified the move by pointing to tepid economic growth and a weakening labour market in recent months. Canada’s gross domestic product growth undershot the bank’s forecast in the third quarter and the unemployment rate jumped to 6.8 per cent in November from 6.5 per cent the month before.
He also pointed to new downside risks to economic activity, including an expected slowdown in population growth after Ottawa’s recent caps on immigration and the threat of U.S. tariffs on Canadian goods, which he called “a major new uncertainty.”
U.S. president-elect Donald Trump has threatened to impose a 25-per-cent tariff on all Canadian imports unless Ottawa does more to address border security concerns. He also campaigned on an across-the-board tariff of 10 per cent to 20 per cent on all imports.
“If tariffs were imposed at the levels that have been suggested it would be very disruptive to the Canadian economy,” Mr. Macklem said in the press conference, adding that the uncertainty created by the threat of tariffs was likely already undermining business investment in Canada.
It’s still unclear whether Mr. Trump will follow through on his threats, and what form any possible tariffs and retaliatory measures might take. As such, the threat did not play a significant role in Wednesday’s rate decision, Mr. Macklem said. But the bank is running scenarios and dusting off old research to try to understand the potential impact of a trade war with the U.S.
“Unfortunately, monetary policy can’t eliminate that uncertainty … [But] with inflation back to 2 per cent, with interest rates now substantially lower, hopefully we can play a role of providing some stability,” he said.
Financial markets responded to Wednesday’s half-point rate cut in a counterintuitive manner, with bond yields rising and the Canadian dollar strengthening slightly against the U.S. dollar. That’s the opposite of what would typically happen with an oversized rate cut. Markets, however, seemed to lean into the bank’s message that it was no longer on autopilot when it comes to additional rate cuts.
“This was, in short, one of the most hawkish upsized cuts in the history of upsized rate cuts across global central banks. It almost had the feel of having an apology note attached to the decision,” Derek Holt, head of capital market economics at Bank of Nova Scotia wrote in a note to clients.
The central bank did consider cutting interest rates by a quarter-point, Mr. Macklem said in the press conference. And he acknowledged that recent economic data were “somewhat mixed,” with a rise in consumer spending and housing market activity suggesting that interest-rate-sensitive parts of the economy are responding to past rate cuts. The bank is not forecasting a recession.
Ultimately, though, the bank’s governing council decided that interest rates no longer need to be restrictive, and so there was no real reason to move by a quarter-point. This sentiment was reinforced by the expected slowdown in population growth next year, which the bank expects will cause GDP growth to undershoot its most recent forecast.
“I think it was the right call because no one thinks that 3.25 [per cent] is going to be low enough,” Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce, said in an interview. “So if there’s a general feeling that we need to get to 3 per cent or lower, then there’s no logic in taking longer to get there.”
The bank did not publish a new formal inflation forecast, but Mr. Macklem said he expects inflation to remain around 2 per cent, on average, over the next couple of years. The annual rate of Consumer Price Index inflation was bang on the bank’s target in October, and has been running inside its 1-per-cent to 3-per-cent target range since the start of the year, with downside pressures on goods prices counteracting upside pressure on housing and other service prices.
The bank expects the federal government’s recently announced GST holiday on some consumer goods to push the rate of inflation temporarily lower, to around 1.5 per cent, in January. However this will be unwound after the GST break ends in February, and the bank will likely look through this blip when setting policy, Mr. Macklem said.
At 3.25 per cent, the policy rate is now at the upper end of the bank’s estimate of the “neutral” range – an interest-rate level that neither restrains nor stimulates economic growth. The bank believes neutral is somewhere between 2.25 per cent and 3.25 per cent.
Investors and analysts still expect several more cuts next year, with interest-rate swap markets pricing in two more cuts by next summer and possibly one more by the end of 2025, according to LSEG data.
“Our view has been that they’ve got to go actually a bit below neutral because they actually want to stimulate growth. So our target was 2.25,” said Mr. Shenfeld of CIBC.
“The reality is that could be supplanted by big fiscal stimulus if the government decides to deliver that. Or we could need to go lower if Canada is hit with major tariffs. So there isn’t a lot of clarity right now on where the end point is. It’s going to depend on whether these other factors step in.”
Editor’s note: A photo caption on a previous version of this story misspelled the last name of Bank of Canada Senior Deputy Governor Carolyn Rogers. This version has been updated.