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Bank of Canada reduces policy rate by 25 basis points to 3%

Bank of Canada Governor Tiff Macklem

The Bank of Canada (BoC) delivered a mixed message Wednesday, announcing a 25-basis-point cut to its key interest rate while sounding alarm bells about potential economic turbulence from a looming trade conflict with the United States.

In lowering the benchmark rate to 3%, Governor Tiff Macklem painted a picture of an economy at a crossroads: stabilized inflation and improving household spending on one side, and the dark cloud of U.S. trade tensions on the other.

The central bank’s latest Monetary Policy Report presents sobering scenarios of potential trade war impacts. Their analysis suggests a 25% U.S. tariff, met with equal Canadian retaliation, could slash Canada’s GDP by 2.5 percentage points within the first year. An even grimmer scenario, factoring in reduced U.S. demand for Canadian goods, projects a 3% GDP reduction.

“A long-lasting and broad-based conflict would badly hurt economic activity in Canada,” Macklem warned, adding that such measures would simultaneously drive up inflation through higher import costs. “Unfortunately, tariffs mean economies simply work less efficiently — we produce and earn less than without tariffs.”
Even without factoring in potential tariffs, the BoC has tempered its growth expectations, revising its 2025 GDP forecast down to 1.8% from the previous 2.1%. This adjustment reflects both the federal government’s reduced immigration targets and weakening investment sentiment amid trade uncertainties.
The trade tensions are already casting shadows over the Canadian economy. The bank’s report highlights declining consumer and business confidence, while the Canadian dollar has depreciated significantly. While interest rate differentials with the U.S. have played a role in the currency’s weakness, the bank emphasizes that trade uncertainty remains the primary driver.
Despite these challenges, the BoC expects inflation to hold steady around its 2% target over the next two years, though this projection assumes no major trade disruptions. The temporary effects of the HST/GST suspension are expected to dissipate when the tax holiday ends in March.
Macklem acknowledged the central bank’s limited tools in addressing multiple economic challenges simultaneously. “Monetary policy cannot offset this,” he said, referring to tariff impacts. “What we can do is help the economy adjust.” However, he noted that with only one policy instrument – the interest rate – the bank cannot simultaneously combat both weaker output and higher inflation.
The rate decision marks the BoC’s sixth consecutive cut, reflecting its ongoing efforts to maintain economic stability amid increasing external pressures. As Canada navigates these uncertain waters, the central bank’s ability to balance growth support with inflation control will be crucial in the months ahead.

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