The Bank of Canada reduces its key interest rate to 2.5% for the first time since March

The Bank of Canada cut its key interest rate by 25 basis points to 2.5% on Wednesday, marking the first reduction since March, as the central bank moves to stimulate a weakened economy.

Economic Reasons for the Decision

The labor market has weakened, inflation excluding gas prices has decreased, and the federal government's removal of retaliatory tariffs against the US has reduced some "upside risks" to future inflation, noted Governor Tiff Macklem in his opening remarks at a press conference in Ottawa.

"Significant uncertainty remains. But with a weaker economy and lower upside risks to inflation, the Governing Council felt that a rate cut was appropriate to better balance future risks"

Impact of US Trade War on Canadian Economy

The economy has faced a series of events since July that influenced the bank's unanimous decision to cut rates, Macklem explained. However, the US trade war continues to play a significant role in the country's overall economic outlook.

"The Canadian economy is affected by both US tariffs and the unpredictability of US trade policy"

GDP declined in the second quarter as the central bank expected, and exports to the US fell after businesses initially built up inventories in response to American tariffs. Some businesses reduced their investments.

Tariffs continue to have a "profound impact" on key Canadian industries such as automotive, steel, and aluminum — as well as additional tariffs on copper and lumber, and Chinese tariffs on canola, pork, and seafood, Macklem noted.

Labor Market Conditions

Meanwhile, the Canadian economy has lost over 100,000 jobs in the past two months, and the unemployment rate has risen to 7.1%.

In addition to significant job losses in tariff-affected sectors, employers in other industries are cutting back on hiring as uncertainty has gripped the Canadian economy, Macklem explained.

Consumer spending was stronger than expected in the second quarter, but this may change as labor market weakness puts pressure on Canadian households, he added.

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However, "we do not expect a recession" if the US maintains its current tariff policy towards Canada, Macklem told reporters. He warned that the situation would change if the tariff regime intensifies.

"Looking ahead, we've seen more stability in US tariffs since July, and in that sense, at least some of the short-term tariff uncertainty has decreased," he said. Therefore, the bank is not looking as far ahead as usual.

Most economists expected the central bank to cut rates on Wednesday, especially after the moderate August inflation report.

Expert Reactions

"This is not a surprise. It was fully expected and I think ultimately welcomed"

That's how Eric Lascelles, chief economist at RBC Global Asset Management in Toronto, commented on the decision.

The economy has been "deeply inefficient" since the start of the US trade war, and it's "appropriate" to get some support from the central bank, Lascelles added.

Lagging growth combined with weak employment and cooling inflationary risks "push the Bank of Canada in the direction of rate cuts".

Inflationary Pressure "More Subdued"

While the overall inflation rate is 1.9%, the Bank of Canada pays close attention to core inflation measures, which exclude volatile sectors such as gas from the overall rate.

The bank's inflation sweet spot is 2%, with a target range of 1% to 3%. Core measures have been fluctuating closer to the upper limit of this range, but their growth rates have slowed in recent months, Macklem noted.

"There's some greater comfort that some of those upward pressures we've seen on core inflation are easing," Macklem noted during a Q&A session with journalists.

Inflationary pressures seem "a bit more subdued," he said, but weak economic growth tipped the scales in favor of cutting the interest rate on Wednesday.

"We don't want Canadians to have to worry about large increases in the cost of living"

Impact on Borrowers

For each 25 basis point cut, holders of variable-rate mortgages can expect to pay about $15 CAD less for every $100,000 CAD in monthly mortgage payments, according to Rates.ca mortgage and real estate expert Victor Tran.

"While the 25 basis point cut will lead to lower variable rates, fixed rates have remained sticky despite recent bond yield drops," Tran said. "This overnight rate cut is unlikely to lead to substantial housing market activity, and the downward market is likely to continue for the foreseeable future."

Future Decisions

The Bank of Canada will make its next interest rate decision on October 29. Many economists expect further rate cuts both this year and in the first half of 2026 as the bank continues to balance economic risks amid ongoing trade uncertainty.