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As widely expected, the Bank of Canada held the overnight rate steady for a third consecutive meeting, while leaving the door open to future cuts — the overnight rate has remained at 2.75% since March, after 7 consecutive rate cuts lowered it from last year’s peak of 5%.

The message from the rate announcement was nuanced. The BoC acknowledged softening Canadian economic growth since January but also pointed to recent data reports remaining broadly resilient relative to more significant downside scenarios that appeared likely in the spring, and upside inflation surprises as reasons not to reduce interest rates further.

The potential “need for a reduction in the policy interest rate” was again reinforced, if there’s further net downward pressure on inflation stemming from a weakening economy. But it would likely take a significantly larger international trade shock than is currently in place to prompt that reaction, and the central bank will also need to continue to take into account fiscal policy loosening, which is better suited to deliver targeted relief to trade impacted sectors than interest rate policy.

With the interest rate decision aligning with expectations, we’ll focus more on the scenario analysis that was again presented in the MPR instead of a central forecast – although with a third current tariff scenario added to the two (upside and downside) scenarios provided in April.

This approach is unusual but allows the central bank to avoid speculating on event probabilities amid extraordinary uncertainty, and instead present a range of potential outcomes.

Bank of Canada’s scenario analysis and how it tracks ours

In the current tariff scenario that tracks the closest to our own base case assumptions, tariffs are assumed to stay unchanged to leave the average U.S. tariff at the 13% level today. 

The BoC’s calculation of the current effective U.S. tariff rate on imports from Canada at ~5% is consistent with our own calculations, as is the calculation that the vast majority of Canadian exports are currently exempt from tariffs via compliance with the USMCA/CUSMA free trade agreement. 

GDP growth in this scenario is projected be soft but positive in the second half of this year with inflation expected to hover around the 2% target as pressures from tariffs and economic softening roughly offset – that is also consistent with our own current base-case projections. 

In the other two scenarios, the average U.S. tariff rate ranges from the 10% in the de-escalation scenario to 28% in the escalation scenario. In the former, Canada’s economy recovers somewhat faster while inflation remains persistently below target. On the other hand, the escalation scenario triggers a prolonged recession lasting until early 2026, with inflation rising above 2.5% later in 2026.

Common assumptions for all three scenarios

Perhaps more revealing are the assumptions common across all three scenarios, one of them being that 75% of tariff-related cost increases will be passed on to consumers over six quarters. Our own assumptions are for a smaller but more rapid pass-through effect, of roughly half of tariffs-related cost increases passed on to consumers within one to two quarters. 

Another key assumption concerns fiscal policy, as projections only incorporate already announced federal and provincial measures. Additional spending could lend to upside in growth in 2026. Our own assumptions in comparison, allow for some additional support from government spending on top of actual budgeted spending included in the BoC’s projections. 

Importantly, U.S. tariffs are treated as permanent fixtures that will impact the economy well beyond the current cycle through reduced investment and productivity. This outlook aligns well with ours, and is particularly concerning given Canada’s decade-long productivity slump that preceded the current trade disruptions. 

Final thoughts and going back to our base case…

Despite recent decisions to hold, past rate cuts from the BoC are likely still taking time to support the economy. But with mortgage rates mostly stabilizing near or above origination back in 2020-2021 origination levels, the effect on households is more like easing off the brakes than pressing on the gas. 

Today, the car is in neutral and the outlook is still hazy. Tariffs in place today have been less severe than feared but Canada as one of the largest trade partners to the U.S., remains particularly vulnerable to protectionist U.S. trade policies. In two days, the latest U.S. self-imposed trade negotiation deadline could result in escalated tariffs beyond today’s targeted but relatively limited levels.

A significantly more negative outlook, one that resembles spring remains a downside risk. While the BoC projects inflation will rise in that kind of a scenario as tariff impacts outweigh economic weakness, further rate cuts would be appropriate if it became clear that the economy was sliding into recession. Barring such deterioration and following our base case, we expect the BoC will maintain current rates going forward.

About the Author

Claire Fan is a Senior Economist at RBC. She focuses on macroeconomic analysis and is responsible for projecting key indicators including GDP, employment and inflation for Canada and the US.