The Bank of Canada (BoC) recently lowered its key interest rate to 2.25 per cent, marking the second consecutive rate cut. This decision comes at a crucial time, reflecting an economy under “immense strain” characterized by weaker-than-expected GDP performance and significant trade uncertainty exacerbated by increasing U.S. tariffs.
The urgency for monetary stimulus became apparent following concerning figures in Canada’s Gross Domestic Product (GDP) report. The economy shrank by 1.6 per cent on an annualized basis in the second quarter, a contraction that was notably larger than the 0.6 per cent economists had anticipated. This marked the first quarterly slowdown in seven quarters.
Tariffs remain a big concern for the country
The primary catalyst for this economic slump was the squeeze on exports caused by U.S. tariffs. Exports declined by 7.5 per cent during Q2, the largest drop seen in five years. In addition to the drag on trade, business investment in machinery and equipment also shrank by 0.6 per cent, the first such decline since the pandemic.
Adding to this trade pressure, the U.S. recently announced an additional 10% tariff increase on goods imported from Canada. This hike was levied after the province of Ontario aired an anti-tariff advertisement featuring Ronald Reagan. This new increase sits over and above existing tariffs; the U.S. had previously imposed levies including 50% on metals and 25% on automobiles, alongside a general 35% levy on all Canadian goods (though most are exempt under a trade agreement). This trade tension led Governor Tiff Macklem to explicitly state that trade uncertainty and U.S. tariffs have weakened the Canadian economy.
Canada’s economy has been growing — for now
Despite the export crisis, the domestic economy showed signs of resilience. Higher household and government spending cushioned some of the impact of the Q2 contraction. Domestic demand grew by 3.5 per cent, supported by a 4.5 per cent jump in household spending and a 5.1 per cent surge in government spending on goods and services.
However, the overall weak economic momentum led economists to forecast that the BoC would cut rates by 25 basis points (bps). The resulting cut, which saw the central bank drop the rate to the lower end of the neutral rate of interest range, suggests a clear need for monetary stimulus, particularly given a weak labor market and a suffering export outlook.
In explaining the decision, Warren Lovely, a managing director at National Bank Financial, noted that the rate reduction occurred because the economy is under immense strain and struggling with a multi-year, or perhaps decade-long, “structural productivity crisis”.
While the BoC provides short-term stimulus, the central bank’s capacity to address the fundamental trade challenges is limited. Governor Macklem has acknowledged that the bank cannot fix the “damage” caused by the trade war with the US.
Looking ahead, the BoC projects Canada’s GDP to grow by 1.2 per cent in 2025, 1.1 per cent in 2026, and 1.6 per cent in 2027. Yet, experts characterize Canadian prospects as “lackluster” until trade certainty can be secured. Although the rate cut shows an “explicit easing bias”, the long-term health of the economy depends heavily on resolving global trade issues.
Despite the economy’s shaky outlook, the TSX has risen by 22% since January, with 2025 proving to be a strong year for Canadian stocks.