BoC Keeps Rates Steady as Trade War Casts Shadow on Outlook

On April 16th, the Bank of Canada announced it will maintain its target for the overnight rate at 2.75%, following seven consecutive rate cuts. The decision reflects growing uncertainty surrounding trade tensions with the United States, which are weighing heavily on Canada’s economic outlook. In a press conference, Governor Tiff Macklem emphasized that the BoC is adopting a wait-and-see approach, seeking more data on the evolving effects of US tariffs on Canadian businesses and households. He presented two possible economic scenarios based on how the trade conflict may unfold - one in which most tariffs are resolved, and one where they escalate further.

By the end of 2024, Canada’s economy was showing signs of renewed strength, with real GDP growth at 2.6% (annualized) and inflation close to the 2% target. However, since the introduction of US tariffs, there has been a notable slowdown. Both business investment and household spending are now expected to be flat in the first quarter of 2025, reflecting weakening exports and softening consumer demand. As a result, GDP growth is projected at 1.8% this quarter, but it may slow further in the second quarter if export activity continues to decline.

Inflation is currently being shaped by two opposing forces - it is being pulled down by weaker household demand, but also pushed up by the rising cost of imported goods, which have been affected by the past depreciation of the Canadian dollar. Businesses have reported that some suppliers have already started raising prices in anticipation of tariffs, adding to cost pressures across the supply chain.

Looking at recent data, inflation fell from 2.6% in February to 2.3% in March, largely due to the end of the GST/HST holiday. However, when comparing March inflation to November 2024 levels (before the holiday began), it has actually increased from 1.9% to 2.3%. During the press conference, Governor Macklem emphasized that forecasting inflation is particularly difficult in the current environment, with major uncertainties ahead. Two factors in particular will shape inflation going forward: the elimination of the carbon tax on April 1st, and whether the US proceeds with the tariffs it paused on April 9th. Trade tensions have also begun affecting the labour market, with the unemployment rate rising by 0.1 percentage point to 6.7%, as businesses start scaling back their hiring plans.

Source: Bank of Canada - April 2025 Monetary Policy Report

To address these uncertainties, the BoC laid out two divergent scenarios in its Monetary Policy Report:

• In the optimistic scenario, where most tariffs are rolled back, the economy experiences only a mild dip in Q2 before resuming growth in the second half of 2025. Inflation falls to 1.5%, slightly below target, as trade risks ease.

• In the adverse scenario, all proposed tariffs are implemented and the trade war deepens. The Canadian economy enters a recession in Q2 2025, with GDP contracting over four consecutive quarters. Inflation climbs above 3% by mid-2026, before easing as demand weakens. Modest growth resumes in 2026 and into 2027.

Source: Bank of Canada - April 2025 Monetary Policy Report

Market expectations reflect the growing divergence in monetary policy paths. According to Bloomberg’s World Interest Rate Probability tool, there is a 62.5% chance the BoC will cut its policy rate by 25 basis points at its next decision on June 4, while the Federal Reserve is expected to hold rates steady. This would further widen the gap between Canadian and US interest rates, adding to downward pressure on the Canadian dollar.

World Interest Rate Probability - Source: Bloomberg - April 16, 2025

World Interest Rate Probability - Source: Bloomberg - April 16, 2025

Given the heightened uncertainty, the BoC emphasized that it will be more cautious and less forward-guiding than usual in its future policy decisions, opting to react as data evolves rather than signaling clear future moves.

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