The Bank of Canada has announced a reduction in its target for the overnight rate to 3%, with the Bank Rate set at 3.25% and the deposit rate at 2.95%. Additionally, the Bank is concluding its balance sheet normalization process by ending quantitative tightening. It plans to resume asset purchases gradually in early March to stabilize and modestly expand its balance sheet in line with economic growth.
The January Monetary Policy Report (MPR) highlights increased uncertainty due to the rapidly changing policy landscape, particularly concerns over potential U.S. trade tariffs. Since the exact scope and duration of any trade conflict remain unpredictable, the MPR presents a baseline forecast assuming no new tariffs.
Globally, economic growth is expected to remain around 3% over the next two years. The U.S. economy has shown stronger-than-expected consumption, leading to an upward revision in its growth forecast. Meanwhile, the euro area faces subdued growth due to competitiveness challenges, and in China, recent policy measures are supporting short-term economic expansion despite underlying structural issues. Financial conditions have varied across regions, with U.S. bond yields rising due to strong growth and persistent inflation, while Canadian yields have slightly declined. The Canadian dollar has weakened against the U.S. dollar, largely due to trade uncertainties and broader U.S. currency strength. Oil prices have been volatile but are currently about $5 higher than projected in the October MPR.
Within Canada, past interest rate cuts have started to stimulate economic activity, reflected in stronger consumer spending and housing market growth. However, business investment remains weak, while exports are benefiting from increased oil and gas export capacity. The labor market remains soft, with an unemployment rate of 6.7% as of December. Job growth has recently picked up after trailing labor force growth for over a year, and while wage pressures have been persistent, they are beginning to ease.
Looking ahead, GDP growth is expected to strengthen in 2025. However, slower population growth due to revised immigration targets will moderate both GDP and potential growth compared to earlier projections. After growing by 1.3% in 2024, GDP is now expected to rise by 1.8% in both 2025 and 2026, slightly above potential growth, gradually absorbing excess supply in the economy.
Inflation remains close to the 2% target, though temporary fluctuations are occurring due to the suspension of GST/HST on certain consumer products. Shelter price inflation remains elevated but is gradually easing. Various indicators, including inflation expectation surveys and price distribution analysis, suggest that underlying inflation is stable around 2%. The Bank anticipates CPI inflation will stay near this target over the next two years.
Excluding potential U.S. tariffs, the risks to the economic outlook are relatively balanced. However, the MPR notes that a prolonged trade conflict could negatively impact GDP and drive prices higher in Canada. Given the economy’s excess supply and stable inflation, the Bank’s Governing Council has decided to further lower the policy rate by 25 basis points to 3%. This continues a series of rate cuts since last June, which have substantially eased borrowing costs, supporting household spending and economic recovery. The outlook suggests a gradual strengthening of economic activity with inflation remaining close to target. However, if significant tariffs are introduced, Canada’s economic resilience may face challenges. The Bank stated they will closely monitor developments and assess their impact on growth, inflation, and monetary policy, reaffirming its commitment to maintaining price stability for Canadians.
https://www.bankofcanada.ca/2025/01/fad-press-release-2025-01-29
https://www.bankofcanada.ca/multimedia/press-conference-monetary-policy-report-january-2025
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Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.
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