Canadian Dollar Weak as Bank of Canada Cuts Rates and Warns of Impact of US Tariffs

January 30, 2025 - Written by Ben Hughes

STORY LINK Canadian Dollar Weak as Bank of Canada Cuts Rates and Warns of Impact of US Tariffs

The BoC cut rates for a sixth time in a row. More cuts look likely and the Canadian Dollar exchange rate complex is weak. The central bank warned about the potential impact of US tariffs on economic growth and inflation.

Wednesday’s Bank of Canada meeting delivered yet another rate cut, its sixth in a row. Rates are now 3%, much lower than policy rates in the US and the UK and there are likely further cuts to come. In response, the Canadian Dollar dropped slightly against the US dollar, although the reaction was muted as the cut was well-telegraphed. The USD/CAD exchange rate is consolidating at levels last seen in 2020.

In another dovish move, the central bank ended its quantitative tightening program and is planning on restarting asset purchases. This is a return to the days of QE, but as its statement pointed out, “The Bank will restart asset purchases in early March, beginning gradually so that its balance sheet stabilizes this year and then begins to grow modestly in line with economic growth.”

The bank’s dovish approach was merited by some of its projections. Growth forecasts were revised downward and it now expects the country's economy to grow by 1.8% in 2025, down from the 2.1% projected in October. For 2026, the growth forecast has been reduced to 1.8%, compared to the earlier estimate of 2.3%.

Inflation forecasts for 2025 were raised slightly to 2.3% from 2.2%, and for 2026, the projection has been adjusted to 2.1% from 2.0%.

Another reason for a dovish approach was the threat of tariffs from the US. President Trump recently said that he would impose a 25% tariff on Canada on the 1st February. This may be a negotiating tactic for stricter immigration controls or it may be implemented immediately – no-one knows what the President's plans are. Clearly, though, the BoC are concerned.

“US trade policy is a major source of uncertainty... A long-lasting and broad-based trade conflict would badly hurt economic activity in Canada. At the same time, the higher cost of imported goods will put direct upward pressure on inflation. The magnitude and timing of the impacts on output and inflation will depend importantly on how businesses and households in the United States and Canada adjust to higher import prices.”

This is a challenging situation for the BoC. If there were tit-for-tat tariffs, growth would take a dive from the already low estimates. As Governor Tiff Macklem warned in the press conference, “If Canada and other nations slapped a retaliatory 25% tariff on the United States, this could cut Canadian growth by 2.5 percentage points in the first year and another 1.5 percentage points in the second year.”

The obvious response to this economic weakness would be to cut rates further, but if inflation was going up at the same time, the BoC would risk exacerbating the situation.

"With a single tool - our policy interest rate - we can't lean against weaker output and higher inflation at the same time," said Macklem. “The bank though could help the economy adjust, especially given that inflation is low,” he added.

This was perhaps a nod to further cuts and there is not currently any concern about rising inflation. On the contrary, both the BoC and the ECB have warned of inflation undershooting their 2% target. The focus is likely to be on addressing economic weakness in the first place and there could be several more cuts to come. The Canadian Dollar is likely to remain under pressure and the recent consolidation range in USDCAD looks to be setting up a break higher.

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TAGS: Canadian Dollar Forecasts