OTTAWA—The Bank of Canada announced a 25 basis point reduction of its key interest rate, its sixth consecutive interest rate decrease since last June, while warning that the imposition of U.S. tariffs remains a “major uncertainty.”
The central bank’s key interest rate now sits at 3 percent. The bank also announced it would be ending quantitative tightening and would restart asset purchases in early March so that its “balance sheet stabilizes and then grow modestly, in line with growth in the economy.”
Macklem noted that the Bank of Canada does not know what tariffs will be implemented, how long they will last, or how Ottawa might respond in terms of retaliatory tariffs and economic support for Canadians. He also said it is difficult for the bank to be “precise” because it has “little experience with tariffs of the magnitude being proposed.”
A “long-lasting and broad-based trade conflict would badly hurt economic activity in Canada,” the governor said, while the higher cost of imported goods would increase inflation. “The magnitude and timing of the impacts on output and inflation will depend importantly on how businesses and households in the United States and Canada adjust to higher import prices,” he said.
Monetary policy—the bank’s policy interest rate—alone would not offset the negative impacts of tariffs, which would include higher inflation and weaker economic output, said Macklem. “We will need to carefully assess the downward pressure on inflation from weakness in the economy, and weigh that against the upward pressure on inflation from higher input prices and supply chain disruptions.”
Macklem said inflation in Canada has remained close to 2 percent, business and consumer expectations have normalized, and shelter price inflation has also been gradually coming down.
The central bank projected that while it expects “some volatility” in consumer price index inflation due to “temporary tax measures”—a reference to the Liberal government’s two-month suspension of the GST and HST on some consumer items—it forecasts inflation to remain close to the bank’s 2 percent target over the next two years.
Macklem also said lower interest rates are beginning to boost economic activity, with household spending on housing and larger items like vehicles increasing. He noted that the labour market remains “soft,” with job creation lagging behind labour force growth and the unemployment rate hitting 6.7 percent in December.
The Bank of Canada forecasts that GDP growth will rise from 1.3 percent in 2024 to 1.8 percent in 2025 and 2026 due to lower interest rates and rising incomes supporting spending. He said that with Ottawa lowering its immigration rates, which had been boosting consumption, the projected increase in GDP is lower than it was in October 2024.
In this scenario, the bank says Canadian exports to the United States would see a “significant” decline in volume, along with decreased oil revenues due to weaker global demand for oil. Canadian business investment would also decline “significantly” due to weaker export activity and the increase in the cost of imported investment goods from the United States.
Lower net export volumes and weaker terms of trade would lead to the Canadian dollar depreciating further from its current price of $0.69 to the U.S. dollar, according to the projection. With less demand, Canadian exporters would be forced to lay off workers, which would negatively impact the rest of the economy by reducing demand for goods and services that are not traded, like housing and restaurant meals.
Inflation would also generally rise in this scenario as a result of the net impacts of two factors that offset each other. Weaker net exports and domestic demand would lower the GDP, create excess supply, and lead to reduced commodity prices as well, weighing on inflation. Meanwhile, retaliatory tariffs on U.S. goods would lead to higher prices passing through to consumers, and along with depreciation of the Canadian dollar, the effects would “more than offset the drag from excess supply and lower commodity prices,” leading to higher consumer price index inflation.
The scenario assumes that the cost increases associated with Canada’s retaliatory tariffs will be gradually passed on to consumer prices over three years. Inflation could increase by 0.1 percentage point in the first year of tariffs, 0.5 percentage point in the second year, and 1 percentage point in the third.
