The Canadian economy slowed to the point that the Bank of Canada was comfortable making another interest rate cut on Wednesday when it lowered its policy rate to 2.25 per cent.
The RSM Canada financial conditions index stands at 0.6 standard deviations above neutral—which implies a modest boost to overall economic activity via the financial channel.
Not surprisingly, the probability of a December rate cut stands at only 7.6% with the market all but implying the central bank will be on hold through next year.
While accommodative financial conditions might ordinarily suggest a pause in monetary policy easing, the October policy rate cuts by the Bank of Canada and the U.S. Federal Reserve are in response to both countries’ economies absorbing adverse policy shocks along with a slowing pace of hiring and wage growth.
The Bank of Canada pointed to an economy facing structural damage caused by the ongoing trade conflict with the U.S. that reduced its capacity and added to its costs.
Uncertainty around the upcoming renegotiation of the trilateral free-trade agreement with the U.S. and Mexico in 2026 will likely damp enthusiasm for private sector investment and may tempt the Bank of Canada—which already downgraded its forecast—to cut rates again next year despite current expectations of an extended pause.
Canada’s economy contracted by 1.6% in the second quarter due to a drop in exports and weak business investment amid U.S. trade actions and heightened uncertainty. The central bank expects weak growth in the second half of 2025, followed by moderate growth in 2026 and 2027 should exports and business investment begin to recover.
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Even though the Bank of Canada attempted to temper expectations of future rate cuts should the economy not reaccelerate, that may be a bit too conservative relative to the needs of the domestic economy.
However, it pointed to the limited role monetary policy can play to boost demand while maintaining low inflation. Trade tensions between Canada and the U.S. are not likely to abate anytime soon, so the Bank of Canada should simply get on with it—in terms of crafting monetary policy to accommodate immediate domestic needs.
While we don’t anticipate another rate cut at the December meeting, we do not believe that monetary policy is on a pre-set course—particularly if the labor market continues to weaken.
Given the potential for further global economic disruption, it is wise that the Bank of Canada clearly communicate its policy to the public, policymakers and the investment community while retaining a modicum of optionality around the need to provide accommodation in the near term should the economy not reaccelerate.
