Bank of Canada cuts target interest rate by 0.25% in January 2025 announcement

Canadians are set to enjoy slightly lower borrowing costs, as the Bank of Canada cut its benchmark interest rate this morning by a quarter of a percentage, bringing it down to 3%. This marks the sixth consecutive decrease from the central bank since last June, which has now lowered its Overnight Lending Rate by a total of 2%, from the previous 5%.

As a result, Canada’s prime rate will lower in kind at most lenders, to 5.2% from 5.45%. Variable mortgage rates, which are priced based on a spread to banks’ prime rates, will also decrease.

Setting a “baseline” amid tariff threats

Today’s rate cut was widely anticipated by markets, which had priced it in at a 98% likelihood – Canada’s latest inflation report, which showed the headline number came in at 1.8% in December, gave the BoC the rationale it needed to again trim borrowing costs.

What’s less clear is the direction the central bank will take next, as threats of 25% US import tariffs – and the potential response to them – hover over policymakers. 

In its announcement, the BoC’s Governing Council acknowledges this looming risk, writing the current outlook is “subject to more-than-usual uncertainty", and that if tariffs were to be imposed, the “resilience of Canada’s economy would be tested.” 

However, as the central bank can only create policy based on the information it actually has, policymakers have provided a baseline for a no-tariff scenario. It points out that its previous six rate cuts have started to boost the economy, and forecasts Canadian GDP will grow by 1.8% in 2025 and 2025, following a total increase of 1.3% in 2024. Inflation – should it not be disrupted by tariffs – is to remain close to its 2% target over the next two years.

“Setting aside threatened US tariffs, the upside and downside risks around the outlook are reasonably balanced,” states the BoC’s announcement. “However, as discussed in the [Monetary Policy report], a protracted trade conflict would most likely lead to weaker GDP and higher prices in Canada.”

Following a scenario where tariffs don’t materialize, the BoC is on track to scale back the frequency and size of its rate cuts, likely delivering two more quarter-point decreases before letting the rate neutralize between 2.5 - 2.75% in the second half of 2025. Sticky core inflation and a resilient job market has given the central bank reassurance that interest rates are no longer restricting the economy, and less stimulus is needed moving forward.

However, these carefully-laid plans can change on a dime. Should President Donald Trump actually follow through and implement tariffs on February 1st, the BoC will find itself countering the effects of stagflation and a deep recession. 

Spiking inflation will promptly undo the progress the central bank has made on pulling Canada’s Consumer Price Index back down to its 2% target, meaning the 10-part rate hiking cycle borrowers endured between early 2022 and late 2023 will largely have been in vain. Meanwhile, resulting job losses, plummeting productivity, and a depreciating loonie will require the BoC to keep its rate low to stimulate the economy, giving it little ammunition to fight inflation’s climb.

In that scenario, the BoC would be likely pass along more rate cuts – potentially another full percentage-point-worth, according to analysis by BMO economists. An economic note titled “25% Tariffs: What If” authored by Douglas Porter and Robert Kavcic, calls for the Bank to slash its overnight rate as low as 1.5%.

While not stating explicitly in today’s announcement that it will cut future rates by a deeper margin, the BoC has made it clear that it will do what’s necessary to maintain price stability, which will likely mean lower interest rates to counter the effects of tariffs.

A widening gap between the BoC and US Fed

Another point of uncertainty for the BoC is the widening gap between its rate cutting path, and the one undertaken by its American counterpart, the US Federal Reserve. The Fed, which will make its own rate announcement today at 2 p.m., is largely expected to hold its trend-setting Federal Funds Rate (FFR), as American economic growth has remained strong, and markets brace for the inflationary effects of the new Presidential administration’s policies.

This will further deepen the divergence between the cost of borrowing in the two countries.

Generally, the two central banks move in lock-step with their monetary policy; having a much lower Canadian benchmark rate than the US is inflationary in of itself, and further weakens the loonie. Generally, the BoC has about 100 basis points (1%) of room to operate below the Fed, without drawing economic consequences. Given the current FFR is 4.33%, today’s BoC cut to 3% leads to a 1.33% difference between the two benchmark rates.

Overall, these two central bank announcements will give markets some sorely needed direction, after weeks of largely remaining on pause in anticipation of tariff threats and the potential policymaker response.

What does today’s rate cut mean for mortgage borrowers?

Variable mortgage rates

Those most directly impacted by today’s BoC rate cut are those who currently have variable-rate mortgages; as a result of the decrease and lowering prime rate, these borrowers will see either their monthly payment, or the amount of their payment servicing interest, lower, depending on whether they have an adjustable-rate mortgage, or one with a fixed payment schedule.

According to Ratehub.ca calculations, today’s rate cut will result in the average variable-rate mortgage holder paying $87 less per month, and $1,044 less per year on their mortgage.

This is based on a homeowner making a 10% down payment on a $676,640* home with a 5-year variable rate of 4.45% amortized over 25 years (total mortgage amount of: $627,854) has a monthly mortgage payment of $3,458.

With today’s 25-basis point rate decrease, their variable mortgage rate will decrease to 4.20% and their monthly payment will decrease to $3,371. 

*The average home price in Canada for December 2024 (CREA)

Fixed mortgage rates

Unlike their variable counterparts, fixed mortgage rates are not directly mandated by the Bank of Canada’s benchmark rate – instead, lenders price them based on bond yield levels. When bond yields fall – as they tend to do in response to central bank rate cuts – lenders can pass those discounts on to their fixed-rate offerings. As of this morning, Canada’s five-year government bond yield had dipped slightly to the 2.87% range, its lowest since December 10. As a result, lenders are expected to pass along some fixed-rate discounts.

However, there isn’t room for fixed rates to dramatically fall; overall, bond investors have been wary of the threat of tariffs and rising inflation, and bond yields have remained elevated since late 2024, bouncing between the 2.8 - 3% range. Should that continue, it will keep a firm floor under fixed rates, the lowest of which in Canada is currently 4.04%.

This all poses a lot of uncertainty for anyone currently shopping for a mortgage rate. If you’re currently on the market, or are coming up to renew your existing term, getting a pre-approval is crucial to guarantee access to the lowest rates available today, even if bond yields – and fixed rates – swing higher in the coming months.

How will this impact loans and investments?

This latest rate cut will also lower interest rates for other forms of debt, including personal loans, car loans, and lines of credit, which are variable-rate products and based on the BoC’s rate. 

Depending on the terms of your loan, you may be able to reduce your repayment amounts, or you could pay off your loan more quickly as more of each payment goes towards the principal instead of interest.

However, it’s a less positive development for those with prime-based banking products such as high-interest savings accounts and guaranteed investment certificates (GICs) – which will now see their return decrease. However, those who have already locked into a GIC will still enjoy a favourable rate for the remainder of their, and favourable rates are still available, before they fall lower on future anticipated cuts.

Also read:

• How US tariffs on Canada could impact you
• December CPI drops to 1.8% due to tax holiday
• What is Canada’s Overnight Lending Rate?
• What is Canada’s Prime Rate?