BMO Predicts Interest Rates Will Fall to 2% by July as Tariffs Take Effect

In the early hours of Tuesday morning, just after midnight, US President Donald Trump followed through on his tariff threat, instituting a 25% levy on goods imported from Canada. This also included a 10% tariff on energy products such as oil and electricity, as well as critical minerals like aluminum. In response, Canada enacted a 25% retaliatory tariff on a broad range of American imports.

The immediate fallout from this escalation in the US-Canada trade conflict is already shaking the financial landscape.

Economic Adjustments and Forecasts

Economists at BMO have swiftly adjusted their interest rate forecasts, reflecting the anticipated impact of a potential North American trade war. Their revised outlook suggests the Bank of Canada (BoC) will likely reduce its policy rate by a quarter of a percentage point at its next four meetings, bringing it down to 2% by July.

BMO economist Douglas Porter noted in a Tuesday morning report, “The net risk is that we eventually go even lower if the Bank is comfortable with the prevailing inflation backdrop later this year.” Previously, BMO had expected two additional rate cuts, in April and July, which would have reduced the rate to 2.50%. Currently, the policy rate sits at 3%, which was achieved through six consecutive rate cuts between June 2024 and January 2025.

Porter emphasized that the BoC’s January rate cut was, in part, a precautionary measure against the looming threat of US tariffs. With this risk now materializing, BMO predicts the central bank will continue to ease policy to counter a potential economic slowdown, which could bring on a recession and further disinflationary pressures.

Recession Risks and Economic Growth Projections

BMO’s economists suggest that, if the tariffs remain in place for the next year, Canada could face a moderate recession, with real GDP growth potentially reduced to just 0.5% in 2025. This slowdown is expected to be driven by disrupted supply chains and growing economic uncertainty. At the same time, inflation is likely to rise modestly, with Consumer Price Index (CPI) projections showing an increase of less than one percentage point from January’s 1.9%.

Porter added that the BoC will need to tread carefully, balancing policy easing with the inflationary pressures from retaliatory tariffs and the potential depreciation of the Canadian dollar.

US Federal Reserve’s Position

On the US side, economists at BMO expect the Federal Reserve to hold off on any rate changes until September, with a 25 basis point cut expected at that time. However, there is a risk of an earlier move if the US economy loses further momentum. This could result in a widening of the Canada-US overnight rate spreads, potentially reaching -225 basis points.

Despite these forecasts, other major Canadian banks, including RBC, are expected to revise their rate predictions in light of the escalating tariff situation. RBC economists, Frances Donald and Cynthia Leach, noted that the longer tariffs remain in place, the more likely it becomes that rates will fall faster and by a larger margin.

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Immediate Impact on Bank of Canada Decisions

As the Bank of Canada’s next interest rate announcement approaches on March 12, analysts predict another quarter-point cut, which would bring the policy rate to 2.75%, marking the lowest level since September 2022.

Scotiabank’s Derek Holt also anticipates a rate cut in light of the tariffs, noting in a Tuesday morning publication that “tariffs tip the balance” toward further monetary easing. TD Economist Rishi Sondhi, in a February 28 report, agreed that the onset of a trade war between Canada and the US virtually guarantees another rate cut.

However, Holt cautioned that Canadian counter-measures, such as retaliatory tariffs, could eventually contribute to inflationary pressures, potentially prompting the Bank of Canada to tighten its monetary policy down the road.

Conclusion

As tariffs continue to reshape the trade relationship between the US and Canada, the economic consequences are becoming increasingly clear. The Bank of Canada is expected to cut interest rates in response to the risks posed by the trade war, while economists brace for a slowdown in growth and a potential recession. The long-term economic impact will depend on how long the tariffs remain in place and how both countries navigate this growing trade conflict.