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The Bank of Canada’s 25 bps rate cut today was in line with market expectations but not ours. It marks a restart of the easing cycle that began in June 2024, continued until March 2025 and had remained on pause since. 

Ahead of the meeting, we believed the case for easing was mixed and narrowly expected a hold. As the BoC laid out, softening in the labour market, a decline in net trade in Q2, and some signs of slowing in core inflation (albeit to rates still above the BoC’s 2% inflation target) reported since the July BoC meeting were enough to tip the balance toward a reduction. 

The overnight rate has now been reduced to 2.5%, closer to the bottom end of the central bank’s estimated neutral range for interest rates of 2.25% – 3.25% (can be thought of as similar to the neutral gear on a car, neither accelerating nor decelerating the economy).

With the decision, the BoC acknowledged that economic weakness has been clearly concentrated in a handful of trade-impacted sectors, and that the ability of monetary policy to counteract that impact is limited. But it has also raised concerns about broader domestic spending in the coming months as the labour market weakens and population growth slows. 

Forward guidance was explicitly limited, with Governor Macklem reiterating that the central bank will continue to respond to new information “over a shorter horizon than usual”. That leaves the central bank with an unusual amount of flexibility, suitable for making monetary decisions under a highly volatile and uncertain economic backdrop. 

We think additional easing from the BoC is likely – the central bank today clearly laid out concerns about the economy, and in the past has rarely cut (or hiked) interest rates just once after initiating or restarting a policy shift. But it’s not guaranteed, should the labour market show clearer signs of recovery and/or inflationary pressures rebuild. 

A more detailed breakdown of demand side factors playing into the decision:

As we’ve highlighted before, a handful of trade-exposed sectors, particularly manufacturing, have borne the brunt of the tariff impact on the Canadian economy to-date. But the resulting uncertainty has affected all businesses alike, slowing hiring demand while slashing investment intentions. 

As a result, job openings have declined, employment has fallen, and wage growth has continued to normalize. To-date, that has not had an impact on household spending. In fact, household consumption was the one component that surprised to the upside in Q2 GDP, and early data suggest continuing resilience in Q3. The BoC, however, expressed concerns about that trajectory in the months ahead. 

Investment is the other area where widespread trade uncertainty is dealing a blow – it contracted significantly in the second quarter and will likely remain softer for the remainder this year. That is likely be true as long as tariffs persists, despite expanding fiscal impulse and easing monetary policy. 

Finally, housing activity has been in a recovery mode since taking a plunge in the spring – resale activity in August reached the highest level this year. That, however, has not yet spurred a turnaround in house prices, which have continued to fall alongside shelter inflation, and is giving the BoC cover to opt for additional rate cut(s) if necessary. Still, house prices are one area that deserves close attention, for what could impede future rate cuts. 

What do we expect going forward?

Looking ahead, the Bank of Canada will continue to face tough decisions as it sorts through distorted and lagged economic data for clues as to where the economy is heading, and what that implies for inflation.

Thinking short-term, the next interest rate decision is scheduled for October 29th, ahead of the federal budget planned for release on November 4th. In that meeting, the BoC will also release another Monetary Policy Report and base case economic projections or scenario analysis. 

Until then, there will be one more round of employment and inflation data (both for September) and the release of the Q3 BoC Business Outlook Survey, all of which will be watched closely given the central bank’s heightened focus on near-term economic data.

Early data for Q3 has already looked better – the trade balance improved in July, and so did manufacturing and wholesale sales – suggesting another quarterly decline in GDP is unlikely. But unless there is a drastic turnaround in softening employment trends and easing core inflation in September, we think the likelihood for another cut in the October meeting is high. 

Beyond then, export and labour market data will continue to rank high on the list of critical indicators for the BoC. As much as those risks are tied to Canada specific tariffs, they will also be swayed by growth in the U.S. economy that has also slowed in the wake of near-century high U.S. tariffs globally. 

Most Canadian exports have to-date remained free from U.S. duties, but close industrial integration means that a slower U.S. economy would put non-tariffed exports at risk as well, broadening and exacerbating the challenges already faced by Canadian producers and manufacturers that could warrant additional easing from the Bank of Canada.

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.