Bank of Canada cuts interest rate to 3.25% as focus shifts to gap with U.S.

REAL ECONOMY BLOG | December 11, 2024

Authored by RSM Canada

The Bank of Canada lowered its interest rate to 3.25 per cent — an overdue move out of restrictive territory given that inflation has largely been tamed.

Expect more rate cuts in early 2025 to get the economy onto an expansionary trajectory. The policy rate should come down to 2.75 per cent within the first half of the year with a series of 25 basis point cuts instead of the recent 50-point drops.

The biggest challenge going forward for the central bank is to manage the rate amid the widening growth and differentials between Canada and the U.S. The Bank of Canada’s interest rate currently stands 150 basis points below the U.S. Federal Reserve’s rate — a gap not seen in two decades.

The Bank of Canada might have to accept this as reality as the U.S. is poised to engage in more inflationary and fiscally expansionary policies next year as Donald Trump takes office, leading to the Fed keeping rates higher and cutting at a slower pace.

Wednesday’s second consecutive cut of 50 basis points came as Canada’s economy saw weak growth and business investments alongside a stagnant job market in an economy with excess supply. Even though headline inflation slightly ticked up to two per cent, broad-based disinflation was seen across several categories.

Tariff and trade policy uncertainty cloud Canada’s economic and investment outlooks. This emphasizes the importance of lowering rates to encourage growth.

At 3.25 per cent, the policy rate is at the top of neutral rate range. The policy rate may get into accommodative territory, at least temporarily, to boost investments.

The tightening of immigration could help keep Canada’s unemployment rate down in 2025, but it will also hurt economically as population growth and consumer spending slow in tandem. The good news: the initial rate cuts this year led to consumer spending picking up ahead of the holiday season.