Bank of Canada cuts interest rate as U.S. trade and tariffs loom large

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The Bank of Canada has cut rates for the second consecutive time bringing the overnight rate to 2.25 per cent.

Policymakers say the decision to lower the rate, as expected by private sector economists, was taken due to ongoing weakness in the economy combined with projections that inflation will remain close to its two per cent target.

Speaking in Ottawa today, the governor of the Bank of Canada said rate cuts of a combined 100 basis points since January are meant to help the economy through what he describes as a “period of adjustment.”

Governor Tiff Macklem says U.S. tariffs and trade uncertainty have weakened the Canadian economy, while also adding costs to many businesses and putting upward pressure on inflation.

“The weakness we’re seeing in the Canadian economy is more than a cyclical downturn,” Macklem said. “It is also a structural transition.”

The bank’s latest decision comes during a time of trade turbulence. Over the weekend, U.S. President Donald Trump announced he was putting an additional 10 per cent tariff on Canada. The move delivered another blow to Canadian businesses whose optimism for a trade deal between Canada and the U.S. was hurt after Trump terminated trade talks with Canada over Ontario’s anti-tariff advertisement.

Macklem suggests a pause could be next if the economy charts along the central bank’s latest projections for the Canadian economy. However, he does admit the bank has to be “humble” in its forecast given the high level on unpredictability.

“If the economy evolves roughly in line with the outlook in our MPR (Monetary Policy Report), Governing Council sees the current policy rate at about the right level to keep inflation close to per cent while helping the economy through this period of adjustment,” Macklem said.

The central bank’s overnight rate now sits at what policymakers estimate to be the lower band of its neutral rate.

How are tariffs impacting the Canadian economy?

In its first Monetary Policy Report, with a base-case projection since January, the Bank of Canada says changes to U.S. trade policy will have a lasting negative impact on economic activity.

In the first half of the year, trade conflict led to a sharp rise in uncertainty that the bank says contributed to a reduction in GDP, a drop in exports and business investment, and a rise in unemployment.

“The entire path for GDP is lower than it was before the shift in U.S. trade policy,” Macklem said, adding that GDP growth should pick up in 2026 as exports and investments start to recover.

In the second quarter alone, the bank says GDP contracted by 1.6 per cent. Steel and aluminum exports declined by about 25 per cent from a year earlier, while exports overall dropped by about five per cent during the second quarter compared to one year before. The bank says the biggest drop was seen in spending on industrial machinery and equipment.

During that same period, consumer spending ticked up in large part because of a spike in vehicle purchases. Residential investment also rose as home sales and housing starts increased.

Annual inflation, meanwhile, jumped unexpectedly in September to 2.4 per cent from 1.9 per cent the month before, driven largely by gasoline and grocery prices. Core inflation, which excludes volatile components such as food, energy and mortgage interest costs, remain within the Bank of Canada’s target range at around 3 per cent.

The central bank believes inflation will settle around two per cent in early 2026 and stay there through 2027. If that changes, the bank says it is “ready to respond.”

What does the future look like?

The impact of tariffs and trade uncertainty is expected to continue into next year with the Canadian economy now on a lower path. Compared to its January report, the central bank estimates the trade conflict will help push GDP 1.5 per cent, or roughly $40 billion, lower than initially expected by the end of 2026. GDP growth, the bank says, should average about 1.4 per cent over 2026 and 2027.

Policymakers expect export growth to resume in 2026, pushed up by foreign demand, but at a lower level than before. Until then, the bank believes exports will drop in the second half of 2025 due to tariffs and slowing U.S. demand. Imports are also supposed to drop through to the end of 2025 because of tariffs and lower domestic demand.

The central bank also projects the global economy to slow to about three per cent in 2026 and 2027.

What’s next?

In less than a week, Prime Minister Mark Carney will release his government’s first budget. Carney has promised generational investments along with fiscal restraint.

The bank says its projections have taken into account pre-budget announcements including a $9-billion increase in defence spending. The bank says it expects government spending to grow at a moderate pace in 2026 and 2027.

The bank’s next rate decision is on Dec. 10.