Introduction to the Bank of Canada’s Interest Rate Decision
The Bank of Canada has decided to hold its interest rate at 2.75 per cent. This decision was made due to the resilience of the economy despite the ongoing global trade war brought on by the U.S. Governor Tiff Macklem stated that the governing council’s decision came from a "clear consensus." The economy has yet to deteriorate sharply in the face of U.S. tariffs, and underlying inflation is showing some stubbornness.
The Reasoning Behind the Decision
The Bank of Canada chose to hold rates in April and June, citing global tariff uncertainty. The decision to hold the interest rate was in line with what economists were predicting leading up to the announcement. The Bank of Canada lowers its policy rate when it wants to stimulate the economy, but keeps borrowing costs elevated when it’s worried inflation will rise. Macklem said that deals made between the U.S. and other world powers in recent weeks have reduced the risk of a "severe and escalating" global trade war, and the impact so far has been less severe than originally feared.
The Current State of Trade
Macklem said the door is still open to lowering rates in the future if necessary. Although headline inflation rose to 1.9 per cent in June, the Bank of Canada sees underlying inflation levels around 2.5 per cent when stripping out volatility and tax changes that are skewing the data. The U.S. has recently struck trade deals with the likes of Japan and the European Union, but those agreements still come with some level of tariffs. Macklem said the nature of those deals suggests "the United States is not returning to open trade."
The Impact of Tariffs
The Bank of Canada will be watching how much tariffs affect business activity and demand for Canadian exports, and whether higher costs from those import duties are passed on to customers. Jimmy Jean, chief economist at Desjardin, told CBC News that the decision came as no surprise, given all eyes are fixed on the tariff deadline of Aug. 1, which is just days away. Jean said the landscape is still favourable to rate cuts, however, and predicts the central bank might cut rates in September. "Certainly we have to expect more pain ahead," Jean said. "And if that’s the case, the time to reduce interest rates won’t be in six months’ time. You have to kind of react in advance in order for a monetary policy to be set at the right level when that weakness materializes."
Possible Scenarios
The central bank published a monetary policy report alongside its rate decision, but that report once again did not include a single, central forecast for the economy as the central bank’s outlook remains clouded by uncertainty. Instead, the bank offered a scenario based on the current tariff level persisting, and two others that outline both a de-escalation and a further ramp-up of tariffs. Each of those case studies sees at least some level of tariffs persisting. The bank’s monetary policymakers also assume a vast majority of Canadian goods will be exempt from tariffs over the coming years thanks to their compliance with the Canada-U.S.-Mexico Agreement as companies rush to get certified.
The Status Quo Scenario
In the status quo scenario, the Bank of Canada sees the economy rebounding through the rest of this year after an estimated decline of 1.5 per cent in annualized real gross domestic product last quarter. The current tariff scenario has real GDP growth coming in 0.5 percentage points lower in 2025 and 2026 compared to the Bank of Canada’s pre-trade war projections in January. Inflation would also hold around two per cent through the end of 2027 in this outcome as the forces pushing prices higher are roughly offset by the forces dampening them.
De-escalation and Escalation Scenarios
A de-escalation scenario would cut U.S. tariffs on Canada in half, resulting in lesser inflation and helping growth rebound faster. Canada’s counter-tariffs are also waived in this example. But an escalation outcome would see the United States place a sweeping 10 per cent tariff on all goods from Canada and Mexico — ignoring the current exemptions for CUSMA compliance — in addition to a threatened 50 per cent tariff on copper imports. Canada would then respond with a 25 per cent tariff on $120 billion of U.S. goods, up from the current tariff scenario of $60 billion. This escalated scenario would see inflation rise and the economy fall into a recession for the rest of 2025.
Conclusion
The Bank of Canada’s decision to hold the interest rate at 2.75 per cent is a sign that the economy is still resilient despite the ongoing global trade war. However, the bank is keeping a close eye on the situation and is prepared to take action if necessary. The possible scenarios outlined by the bank show that the economy is still uncertain and that tariffs will continue to have an impact. It’s essential for Canadians to stay informed and understand how these decisions will affect their daily lives and the economy as a whole. As the trade situation continues to evolve, the Bank of Canada will be ready to respond to new information and make decisions that will help stabilize the economy.
