Bank of Canada Likely to Cut Rates 25 Bps to Cushion Economy from Tariffs

The Bank of Canada is poised to make a significant move on Wednesday, March 12, 2025, by cutting its overnight rate by 25 basis points. This decision comes amidst a cloud of uncertainty due to the shifting trade war with the United States, which has imposed sweeping tariffs on Canadian goods. The central bank faces a delicate balancing act: supporting economic growth while managing inflation and the potential fallout from the tariffs.

The trade war with the U.S. has introduced a high degree of uncertainty into the Canadian economy. U.S. President Donald Trump's tariffs, which went into effect on March 4, have shifted in nature with a series of pauses and amendments. This volatility makes it difficult for economists and policymakers to predict the long-term impact on the economy. Randall Bartlett, Desjardins Group deputy chief economist, described the situation as "almost anyone’s guess," highlighting the unpredictable nature of the trade dispute.

The Bank of Canada's decision to cut rates is aimed at providing a cushion for the economy against the potential downturn caused by the tariffs. Most economists expect the central bank to deliver another quarter-point rate cut, bringing the benchmark rate to 2.75%. This move is intended to support consumer spending and business investment, which have shown signs of resilience despite the economic headwinds.



The rate cut is expected to have both short-term and long-term effects on the economy. In the short term, a lower interest rate makes borrowing cheaper, which can encourage consumers to take out loans for big-ticket items like cars and homes. This increased borrowing can lead to higher consumer spending, as seen in the surge in retail activity late last year due to previous interest rate cuts. For businesses, a lower cost of capital can stimulate investment, which is crucial for economic growth.

However, the long-term effects of the rate cut are more uncertain. The Bank of Canada faces a difficult task of balancing weak growth and rising inflation tied to the tariff shock. A rate cut could help to smooth the impact on the economy, but it cannot solve the tariff issue. The central bank will need to carefully monitor the situation and adjust its policy rate accordingly to keep inflation expectations well anchored to the two per cent target.

One of the key implications of the rate cut is its impact on the Canadian dollar. The loonie is vulnerable not only to hits from the trade war but also to a widening differential between policy rates in Canada and the U.S. If the Bank of Canada drops its policy rate too sharply, the loonie could fall as well, leading to a bigger surge in inflation on food and other goods imported from the U.S. This could have long-term negative effects on economic growth if not managed properly.

The Bank of Canada's decision to cut rates aligns with its mandate to maintain inflation at the 2% target. The central bank recognizes the potential for a prolonged trade war to have significant and lasting effects on the economy. By using its policy rate to help "smooth" the impact on the economy, the Bank of Canada is taking proactive measures to support the economy and prevent a recession.

In conclusion, the Bank of Canada's decision to cut rates by 25 basis points is a strategic move to cushion the economy from the potential downturn caused by the trade war with the U.S. While the short-term effects of the rate cut are expected to be positive, the long-term implications are more uncertain. The central bank will need to carefully monitor the situation and adjust its policy rate accordingly to keep inflation expectations well anchored to the two per cent target. Investors and economists will be closely watching the Bank of Canada's next moves as the trade war continues to unfold.