On Wednesday, January 29th, at its regular policy meeting, the Bank of Canada (BoC) reduced the policy rate by 0.25 per cent, bringing it down to 3 per cent. This is the sixth rate drop in a row from the BoC (all happening since June) and this rate reduction will cause banks and mortgage lenders to cut their consumer prime rates for customers with variable rate mortgages and lines of credit. With most banks and mortgage lenders, this will mean a drop in their prime rate to 5.2 per cent (5.35 per cent for TD).

For variable rate mortgage holders whose mortgage payments change with prime (some lenders call these adjustable rate mortgages) this will mean a decrease in mortgage interest costs of about $20 per one hundred thousand of mortgage debt (assuming a 25 year amortization).

Why did the Bank of Canada cut the policy rate?

The BoC emphasized 2 key factors in its decision to cut the policy rate today. First, inflation seems to be holding at around the 2% target rate and second, the economy is currently in a state of oversupply.

Regarding inflation, the federal government’s GST holiday which rolled out in December is unfortunately skewing the data for real inflation figures (causing the December inflation number to be artificially low), and this will continue for the January report coming out early next month. However, the general consensus among economists is that even if the GST holiday impact was removed from the numbers, inflation seems to be staying in hand at roughly 2%.

As far as the economy more generally, GDP growth is forecast to continue to strengthen marginally over 2025 and 2026, coming in at 1.8% for both years (compared to 1.3% in 2024). Combined with our currently soft labour market (the unemployment rate in December was 6.7%), these factors mean that our economy can benefit from a bit of stimulus to increase both consumer spending and business investment and hiring, without it posing a danger of being inflationary.

What’s next for the policy rate?

All of the above forecasts and future predictions are based on current hard data, and the BoC was very clear in its announcement that they do not factor in any possible impact of the looming tariff battle with the US. If President Trump does move ahead with tariffs and Canada is forced into a tariff battle with our largest trading partner, these forecasts will get tossed out the window and the BoC will need to respond with either cuts or increases to the policy rate depending on how our economy is affected.

As things stand right now, President Trump is threatening broad based tariffs of 25% on all Canadian goods imported into the US and our provincial and federal governments are preparing counter-tariffs to be imposed on many of the goods we import from the US. If this scenario does play out and continue for more than a few months, it would result in very negative impacts on our economy across many sectors. Unemployment will go up due to layoffs in many sectors and our GDP growth would likely stall out or even reverse (meaning we’d enter a possible recession). At the same time, prices of many goods and services would increase drastically due to the tariffs businesses would be paying on goods imported from the US for which there are no easy national substitutes, leading to inflation pushing up from 2%. Since the Bank of Canada’s overriding mandate is to maintain price stability, it would have to increase the policy rate to fight inflation even though that will further depress the economy. This would leave it up to federal and provincial governments to pass legislation to help offset the negative effects of the tariff battle and fight a recession (through stimulus programs), but with our federal government currently prorogued and likely entering an election this spring/summer, it would likely be many months before that could happen.

The next scheduled BoC rate announcement is March 12th, 2025, but due to the tariff war uncertainty right now, it’s anyone’s guess as to whether the BoC will be looking at raising or lowering the policy rate and what the rest of 2025 and 2026 will look like for the Canadian economy.

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