Experts expect the Bank of Canada to drop the overnight interest rate on Wednesday, but beyond that it is anyone’s guess
In the lead-up to the 2024 U.S. presidential election, interest rate theory was fairly simple.
If inflation was higher than a target number set by the Bank of Canada (around two per cent), then interest rates needed to rise to slow down the economy and reduce the cost of living.
On the other hand, if inflation dropped too low and there was little economic growth, then interest rates needed to fall to encourage consumer and commercial borrowing to stimulate the economy.
The perfect example was COVID-19, when inflation initially fell close to zero (recall those few months of 85 cents for a litre of gas) and interest rates dropped dramatically.
Then, pent-up consumer demand and other factors led to soaring inflation, and a subsequent increase in interest rates. More recently, rates have dropped as inflation has fallen back closer to two per cent.
Here is what to know about interest rates over the next few months:
Where are interest rates now?
It is the Bank of Canada that sets the overnight interest rate, which commercial banks generally use to set interest rates.
In February 2022, the overnight rate began to climb after almost a year of a COVID-induced low of 0.25 per cent.
The rate peaked at five per cent and stayed there until June 2024, when the Bank of Canada started to lower the rate again.
What happens on Wednesday?
What are the experts saying?
According to Bloomberg, a combination of emerging economic weakness and Trump’s on-again, off-again tariff threats are “casting a cloud of uncertainty over the Canadian economy and its ability to trade with its biggest customer.”
Bloomberg reports the Bank of Canada is expected to cut its overnight rate for the seventh-straight meeting on Wednesday.
Randall Bartlett, Desjardins Group deputy chief economist, says the Bank of Canada faces a difficult task — setting monetary policy at a time when inflation has shown signs of stubbornness, while there are risks of a sharp downturn tied to threatened U.S. tariffs.
“It’s a very difficult position for the Bank of Canada to be in,” Bartlett said.
Inflation is likely to rise in the near-term from the trade disruptions, he said, and job losses in hard-hit sectors could quickly pile up if those industries don’t receive tariff reprieves.
Desjardins expects Canada would fall into a recession by mid-year if steep tariffs remain in place.
LSEG Data & Analytics reported financial markets were largely tilted toward a quarter-point rate cut on Wednesday.
Andrew Grantham, senior economist with CIBC Capital Markets, said in a note to clients that the central bank “can’t solve the tariff issue” with rate cuts but it can help the economy transition through the turbulence.
CIBC expects the bank to deliver a quarter-point cut on Wednesday, lowering the benchmark rate to 2.75 per cent, with more cuts to follow this year if trade uncertainty lasts.
Why aren’t fixed-rate mortgages dropping as much?
Since June 2024, the overnight rate has fallen two per cent. However, over the same period, the rate for a five-year, fixed mortgage rate has not.
Fixed mortgage rates are influenced by bond market movements, rather than directly by the Bank of Canada rate cuts.
So variable rates have come down with the overnight rate, but Canadian bonds have remained relatively strong and so fixed rates have not followed suit. However, the current economic uncertainty is lowering bond returns, with CIBC last Friday offering a five-year-fixed rate of less than four per cent.
According to rate hub, further declines will depend on economic conditions, inflation expectations and global trade developments. If concerns over U.S. import tariffs or inflation risks push bond yields higher, fixed mortgage rates could increase.
B.C. real estate analyst Steve Saretsky points out that the opposite could also happen, if bond yields get weaker, rates could continue to fall.