The Bank of Canada took bold action Wednesday to reduce its key interest rate by 25 basis points to 2.5 per cent as a slowing economy, rising unemployment, weaker oil prices and the effects of U.S. tariffs on the margin all likely contributed to the unexpected policy action.
A weaker economy, growing labour slack and softer oil prices created the conditions under which the central bank can confidently look through a likely short-term increase in inflation. This also sets the stage for future rate cuts to provide accommodation for Canada’s economy.
Since the effective tariff rate on Canadian exports into the U.S. is 3 per cent, it suggests the Canadian economy has issues beyond trade tensions and next year’s free-trade deal renegotiation—which likely factored into today’s rate cut.
However, the specific mention of potential inflation risks from global protectionism and tariffs denotes a bit of caution by the Bank of Canada going forward—along with the potential rate path.
From RSM’s point of view, the lack of forward guidance from the Bank of Canada creates a modicum of optionality around the path of monetary policy.
It’s clear that a weaker labour market and the likely return of inflation to at or below 2 per cent are in the process of creating the necessary policy space for the central bank to cut its policy rate at least one more time—and possibly more—going forward.
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