The Bank of Canada dropped its key interest rate on Wednesday for a second consecutive time despite economic uncertainty fuelled by the U.S. trade war.
While inflation appears to be mainly under control but slightly higher than anticipated in September at 2.4% after registering 1.9% in August, the Canadian economy is showing troubling signs as U.S. tariffs are starting to take a bite on economic growth.
Bank of Canada Governor Tiff Macklem warns U.S. President Donald Trump’s continuing use of import tariffs on a wide range of Canadian goods — including vehicles, steel, aluminum, and lumber — will have a weakening effect on the Canadian economy in the second half of the year.
What is the latest drop?
The Bank of Canada lowered it benchmark interest rate to 2.25%, dropping a quarter of a point for a second time following three straight decisions to hold off on any movement as U.S. tariffs took hold.
While the drop is welcome news to many Canadians, it may spark higher inflation as spending is expected to increase.
Macklem said the Bank of Canada is also returning to its “usual practice of providing a projection for the global and Canadian economies in this Monetary Policy Report.”
The Monetary Policy Report is a quarterly review that projects inflation and growth in the Canadian economy, and financial risks the country faces.
Why the latest drop?
Because of the ongoing U.S. trade war, the Canada economy is undergoing upheaval as the country seeks out new trading partners.
“The structural damage caused by the trade conflict reduces the capacity of the economy and adds costs,” Macklem said.
“This limits the role that monetary policy can play to boost demand while maintaining low inflation.”
Due to trade uncertainty, Canada’s economy contracted by 1.6% in the second quarter from fewer exports and weak business investment. However, household spending grew at a healthy pace.
The Canadian dollar has slightly been devalued against the U.S. dollar, Macklem noted, while adding the country’s labour market remains soft after adding jobs in September following months of losses.
How could it impact Canadians?
The interest rate is the main tool the Bank of Canada uses to control inflation and higher prices for what you pay at the checkout counter.
But if the Canadian economy is struggling to expand, inflation could dip below 2%.
By lowering the interest rate, the Bank of Canada is encouraging people and businesses to spend more and invest in growth by paying less on loans and mortgages while earning less on what is in their savings accounts.
“The Bank is focused on ensuring that Canadians continue to have confidence in price stability through this period of global upheaval,” Macklem said.
What to expect next?
As U.S. tariffs have a negative impact on the global economy, Macklem said trade investment has weakened.
“Trade relationships are being reconfigured and ongoing trade tensions are dampening investment in many countries,” he said.
If the trade war continues, the Monetary Policy Report is predicting that the global economy slows down from about 3.25% in 2025 to about 3% in 2026 and 2027.
The next Bank of Canada interest rate update is set for Dec. 10, while the next Monetary Policy Report will be released on Jan. 28, 2026.
Recent history of interest rates
Around this time last year, the Bank of Canada dropped the key interest rate by half a percentage point from 4.25% to 3.75%.
Inflation in recent years caused the Bank to hike the key lending rate to 5% in the summer of 2023.
The COVID-19 pandemic forced the Bank to lower its rate to 0.25% in March 2020 as the global economy came to a crashing halt.
However, the rate saw major increases as inflation took hold in 2022, going from 1% that April to 2.5% in July and 4.25% in December.