Canada central bank cuts key interest rate to 3.0%

The Bank of Canada on Wednesday cut its key lending rate 25 basis points to 3.0 percent, noting that US tariff threats are creating uncertainty for the economy.

"The economy is expected to strengthen gradually and inflation to stay close to target (of two percent)," the central bank said. "However, if broad-based and significant tariffs were imposed, the resilience of Canada's economy would be tested."

"A protracted trade conflict (with the United States) would most likely lead to weaker GDP and higher prices in Canada," it added.

US President Donald Trump has said he would slap 25 percent tariffs on imports from US neighbors Canada and Mexico as early as February 1.

Retaliation by Canada in the form of matching counter tariffs, which officials have told AFP are already in the works, risks leading to a trade war between the two allies.

Canada's central bank said the situation has created "more-than-usual uncertainty" with the scope and duration of such a trade conflict "impossible to predict."

It noted that the Canadian dollar has depreciated materially in advance of the tariffs being imposed. Oil prices have been volatile and rose above the bank's last projection in October 2024.

Overall, the Canadian economy has recently picked up, despite weak business investment and a soft labor market, with both strong consumption and housing activity expected to continue.

The bank, however, lowered its growth forecast to 1.8 percent in both 2025 and 2026, down from 2.1 percent and 2.3 percent, respectively.

The central bank had been aggressively cutting interest rates since last June, and with inflation now largely under control analysts are tentatively expecting rates to be reduced by a further 75 basis points by year's end.

But tariffs, according to the central bank, would see Canadian exports -- which mostly go to the United States, represent 20 percent of Canada's economy and support almost two million jobs -- plunge.

There would also be significant job losses and a further depreciation of the Canadian dollar and drop in business investment.

In a baseline scenario, the bank said Canadian GDP growth would be 2.5 percentage points lower than with no tariffs in the first year, and 1.5 percentage points lower in the second year.

"Unfortunately, tariffs mean economies simply work less efficiently -- we produce and earn less than without tariffs. Monetary policy cannot offset this. What we can do is help the economy adjust," central bank governor Tiff Macklem said.

TD Bank economist James Orlando commented in a research note: "We are still hopeful that tariff threats are more of a negotiation tactic, meaning they would be temporary and carry less long-term impacts."