The Bank of Canada announces a 25 basis point rate cut in response to tariff impacts. Uncertainty remains regarding future policy paths.

The Bank of Canada announced on Wednesday, during its interest rate decision meeting, that it would cut the overnight rate by 25 basis points to 2.5%, marking the first rate cut since March of this year. This move was in line with market expectations and aimed to address the ongoing impact of U.S. tariffs on the Canadian economy and job market. However, the central bank did not provide a clear path for future easing in its statement, indicating that decision-makers are carefully balancing economic downturn pressures with inflation risks. Governor Macklem stated in a press conference that recent economic growth slowdowns and reduced inflationary risks led the decision committee to unanimously agree that lowering rates would help "better balance economic and inflation risks." Canada's GDP shrank by 1.6% on an annualized basis in the second quarter, mainly due to a significant decline in exports and business investment, with the central bank acknowledging that "U.S. tariffs and trade uncertainty are severely dampening economic activity." The worsening labor market conditions were another major factor triggering the rate cut. Data shows that Canada lost over 106,000 jobs in July and August, pushing the unemployment rate to 7.1%, with most losses concentrated in the manufacturing, retail, and wholesale sectors heavily impacted by trade issues. Signs of a slowdown in hiring are also starting to show in other industries. The central bank pointed out that while consumer and real estate activities are still experiencing "healthy growth," slowing population growth and weak employment prospects will limit household spending. Tariffs have become a core factor in the current economic weakness. The U.S. government, under President Trump, imposed a 35% tariff on Canadian goods not compliant with the North American Free Trade Agreement, and additional tariffs on industries like steel, aluminum, automobiles, and copper. Canadian Prime Minister Trudeau recently lifted most retaliatory tariffs on the U.S. to ease trade tensions and relieve domestic inflation pressure. Macklem emphasized, "Tariffs have had a profound impact on key industries such as automobiles, steel, and aluminum." Although the rate cut decision was unanimous, Macklem revealed that policymakers also discussed the possibility of keeping rates unchanged. The statement removed the wording from the July meeting about "further possible rate cuts in the future," changing it to indicate a "cautious approach," as global trade uncertainties would continue to increase economic costs while limiting growth prospects. Market interpretations suggest that while the central bank is restarting easing measures, it does not want to enter an aggressive rate-cutting cycle too soon, to prevent input-driven inflation risks arising from global protectionism. Stephen Brown, Deputy Chief North American Economist at Capital Economics, pointed out that the policy rate has fallen below the midpoint of the central bank's neutral range of 2.25% to 3.25% for the first time since the early days of the COVID-19 pandemic, indicating a leaning towards an accommodative policy. Following the rate decision announcement, the Canadian dollar weakened against the U.S. dollar, reaching intraday lows. The two-year Canadian government bond yield slightly rose by 2 basis points to 2.48%, while the ten-year yield remained around 3.15%, almost 90 basis points lower than U.S. Treasury yields. Interest rate swap markets show that investors have fully priced in at least one more rate cut in this cycle, with around a 50% probability that the central bank will cut rates again in the October meeting. Katherine Judge, an economist at the Canadian Imperial Bank of Commerce, stated, "With the high unemployment rate and cancellation of retaliatory tariffs, inflation will be suppressed, and we expect a further 25 basis point cut in October." However, there are also cautious viewpoints. Tony Stillo and Michael Davenport from Oxford Economics believe that this does not mark the beginning of a deep easing cycle, projecting that the central bank will maintain the policy rate at 2.25% until 2026 after another rate cut in October. They noted that large-scale fiscal stimulus expected in this year's federal budget could be the main driver supporting the economy, with monetary policy playing a supporting role. Doug Porter, Chief Economist at the Bank of Montreal, stated, "This rate cut has better balanced the economic and inflation risks, and the central bank will dynamically adjust policies based on short-term economic data." He predicted that there would be two more rate cuts in the coming months. Core inflation indicators continue to decrease, with the central bank's preferred measures of trimmed mean and median indicators falling to around 3%, and broad inflation pressures nearing 2.5%. Wage growth remains subdued, and the Consumer Price Index (CPI) year-on-year growth rate is hovering around 2%. Macklem stated, "The latest data shows that the upward pressure on potential inflation is weakening." The central bank is closely monitoring how tariff disturbances and supply chain disruptions transmit to consumer prices and inflation expectations. Macklem noted that while U.S. tariff policies are relatively stable, the upcoming renegotiation of the North American trade agreement will introduce new uncertainties.