Bank of Canada should have cut interest rates instead of pausing

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Jeremy Kronick is vice-president and director of the Centre on Financial and Monetary Policy at the C.D. Howe Institute, where Steve Ambler, a professor of economics at Université du Québec à Montréal, is the David Dodge Chair in Monetary Policy.

The Bank of Canada left its policy interest rate at 2.75 per cent on Wednesday, confirming market expectations. Data showing stubbornly high underlying inflation and robust-looking first-quarter gross domestic product growth had led markets to price in only about a 20-per-cent probability of this cut.

While we understand the bank’s thinking, we believe it should have cut.

In April, we argued that the high degree of economic uncertainty and some concerning core inflation measures made a good case to pause rate cuts. So, if uncertainty remains as high as it does, and we saw stronger-than-expected GDP numbers last Friday alongside rising core inflation – Consumer Price Index-trim to 3.1 per cent and CPI-median to 3.2 per cent – why a cut this time?

Three reasons: increasing unemployment, sagging housing markets and weakness behind the strong-looking data. This flagging on the demand side will outweigh potential inflationary pressure from the impact of tariffs and trade wars on the economy’s supply side. This weakness means the Bank of Canada will have to cut its policy rate sooner or later. Doing it now may help prevent the economy from sliding into recession, something that is looking increasingly likely.

Bank of Canada: The latest news, analysis and reaction on the rate decision

We aren’t the only ones worried about a downturn. The economics departments of the major Canadian banks are seeing the same thing. Four of the six major Canadian chartered banks are predicting at least one quarter of falling GDP this year, and three of them are predicting two quarters of it.

The stronger-than-predicted GDP growth in the first quarter of the year (2.2 per cent annualized) masks some underlying weaknesses. The key driver of growth was exports, much of it caused by U.S. importers front-running tariffs. Consumer spending barely grew in the first quarter, and (already very weak) gross fixed capital formation fell.

As for housing, expectations were that as the bank cut the overnight rate off its 5-per-cent peak, the housing market would start to take off – an argument for the bank to cut rates only slowly. However, the housing market has slumped amid tariffs and economic uncertainty. In March, Canadian home sales were the lowest they’ve been in that month since 2009, during the global financial crisis. The ratio of sales to new listings hasn’t been this low since February, 2009.

The strongest negative signals are coming from the labour market.

After a fall of more than 30,000 in March, employment was stagnant in April, despite the hiring of temporary workers for the federal election. Moreover, employment among core-aged individuals (25 to 54 years old) fell by 36,000 in April. Core-aged employees are traditionally the most strongly attached to the labour force, and a fall in employment in this group is typically a sign of layoffs. The unemployment rate increased again in April and now stands at 6.9 per cent.

Cutting the policy interest rate when core inflation measures (which strip out the most volatile components of the Consumer Price Index) are moving up would have been a communication problem for the bank. But we think a cut would have been appropriate.

The bank pays attention to core inflation as an indicator of where inflation may be headed in the medium term. The drop in headline inflation to 1.7 per cent wouldn’t be much help in this regard as it is almost entirely due to the elimination (at least in practice) of the federal consumer carbon levy. The key would have been to convince the public that any increase in headline inflation that arises from the current spike in core measures is temporary, and that economic weakness will bring price growth down in the medium term.

Falling employment among core-aged individuals is an especially important part of that messaging. We’d also add that one major difference between the situation now and in 2021, when inflation started to take off, is that the growth in broad monetary aggregates, which is strongly linked to inflationary pressures further down the road, is much weaker.

After GDP growth in the first quarter of 2025 came in stronger than anticipated, and core inflation measures jumped above 3 per cent, it was understandable that the bank would hold off lowering its policy rate. But, in our view, the signs of economic weakness were too strong to ignore. With uncertainty likely to remain elevated, these signs will likely continue. And with them will come more rate cuts.