The Bank of Canada has cut interest rates by a quarter-point, lowering them from 2.75%. Economists widely expected this move after a previous rate cut in March. Rate cuts began last June. Global economic growth is slowing down. Core inflation has been around 3% lately, but the earlier increases in price have decreased. Underlying inflation is about 2.5%. Removing most tariffs on US goods should help ease price pressures.

Governing Council’s Careful Approach

The Governing Council is being cautious due to various risks and uncertainties. Trade changes are likely to continue causing costs, which can impact economic activity. The Council wants to support growth while keeping inflation in check. The Council is looking into the impact of US tariffs and changes in trade relationships on exports. They are also keeping an eye on how these factors might influence business investment, jobs, and household spending. Disruptions in trade and supply chains could affect consumer prices and inflation expectations. Before the announcement, the USD/CAD exchange rate was 1.3761, which increased by 23 pips. The market largely anticipated the rate cut and expects more easing by June, including today’s 25 basis-point reduction. With the Bank of Canada easing rates while the US Federal Reserve holds steady, the gap in policies between the two countries is growing. Recent US data from August 2025 shows core inflation still at 3.2%, indicating that the Fed is unlikely to lower rates soon. This situation favors strategies that benefit those holding US dollars against Canadian dollars, likely pushing the USD/CAD rate towards 1.4000, a level last seen in early 2024.

Outlook for Canadian Yield Curve

The rate cut should lead to a steepening of the Canadian yield curve, a common pattern seen at the beginning of past easing cycles. This suggests that short-term bond yields will drop faster than long-term yields. Traders should consider steepener trades, which involve buying two-year Government of Canada bond futures (BAX) and selling ten-year bond futures (CGB). The Bank’s cautious position indicates that future rate cuts depend greatly on incoming data, especially since underlying inflation is still around 2.5%. The market is currently pricing in a 52% chance of another cut in October. Therefore, upcoming employment and CPI inflation reports are crucial for market movement. We recommend buying options straddles on the Canadian dollar, which can profit from significant price changes in either direction as a good way to manage this risk. Looking ahead, the market expects just over one more 25-basis-point cut by June 2026. This seems low since Canadian business investments have already decreased for two consecutive quarters in 2025, a sign of a potential economic slowdown. We believe there’s an opportunity to position for a more aggressive cutting cycle than what the market currently indicates, possibly through interest rate swaps that pay a floating rate and receive a fixed rate. Create your live VT Markets account and start trading now.

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