Bank of Canada cuts key rate to 3% as tariffs threat loom

The Bank of Canada delivered another interest rate cut on Wednesday, reducing its policy rate by a quarter percentage point to three per cent. But looming U.S. tariffs are weighing on the central bank’s economic outlook.

The cut, the central bank’s sixth consecutive one since June, comes as the central bank said inflation is sitting around its two per cent target and the economy is picking up speed.

“There are signs economic activity is gaining momentum as past interest rate cuts work their way through the economy,” Bank of Canada governor Tiff Macklem said in prepared remarks.

But Canada’s economic outlook is clouded in uncertainty with U.S. tariffs looming.

Donald Trump has threatened Canada with 25 per cent tariffs on all goods, but when the U.S. President might make good on his threat – and to what extent – remains to be seen.

In its monetary policy report released Wednesday, the Bank of Canada revised lower its GDP forecast.

It expects the country’s GDP to grow by 1.8 per cent in 2025 and 2026, down from its previous projections of 2.1 and 2.3 per cent, respectively.

The revised projection factors in lower population growth – and population decline in 2026 amid new federal immigration targets – and a downward revision to business investment from increasing policy uncertainty.

But the forecast assumes Trump won’t make good on his tariff threat. If he does, the outlook is far bleaker.

“We don’t know the scope of retaliatory measures or what fiscal supports will be provided,” Macklem said.

“And even when we know more about what is going to happen, it will still be difficult to be precise about the economic impacts because we have little experience with tariffs of the magnitude being proposed.”

The central bank presented four scenarios if the U.S. hits Canada with 25 per cent tariffs, and Canada responding in kind dollar-for-dollar.

The impact of tariffs, the Bank of Canada projected, would lower Canada’s GDP by 2.4 per cent in the first year whenever tariffs come in.

Such a scenario – what the central bank is calling its “benchmark calibration” – assumed Canadian exports react to price changes in line with historical norms and the cost of tariffs were fully passed on to consumer prices over three years.

So, if Trump imposed tariffs this year, the shock could be large enough to send Canada into a recession – by comparison of the Bank of Canada’s projection of a 1.8 GDP growth in 2025.

In another scenario, using the same parameters as the benchmark except the cost of tariffs are passed on in half the amount of time, the impact to Canada’s inflation rate in the first year could be 0.8 per cent in the first year, and 1.3 per cent in the next year.

In December, the Bank of Canada signalled that more rate cuts would be coming through 2025, but it would take a more gradual approach to them – in contrast to the back-to-back jumbo cuts that closed out 2024.