The Bank of Canada has decided to lower interest rates by 25 basis points because of a shift in the risk balance. The inflation rate has mostly remained stable. Earlier this year, core inflation was rising, but that trend has now slowed down. Although inflation signs are mixed, overall inflation pressures seem to be more controlled. A slowing economy is expected to keep inflation low. Tariffs are hurting the Canadian economy, especially in some sectors. The bank will keep an eye on exports and how businesses adapt to higher costs, with a focus on risk balance as October approaches. Some counter-tariffs, especially on food, have been lifted. Economic forecasts suggest a growth rate of around 1% for the second half of the year, indicating no recession is expected.

Market Expectations and Projections

Market expectations for another rate cut in October have dropped to 42%, down from 52% before the Bank of Canada’s decision. Projections for next summer have also changed slightly, with 29 basis points now expected instead of the previous 30. Currently, there are no plans to change the deposit rate. The Bank still has various policy tools available for adjustments before any deposit rate changes. The Bank of Canada has officially started a cutting cycle due to a weakening economy. This shift in risk balance signals that they expect minimal growth of 1% in the second half of the year. This aligns with recent data from Statistics Canada, which shows that the economy barely grew in the second quarter, confirming the current economic slowdown. Although the market has reduced the chances of a cut in October, we see this as an opportunity. The key message is that inflation pressures are manageable and the economy needs support, suggesting that rates may continue to decrease. We should consider preparing for this by receiving fixed interest rate swaps set for early 2026, as the market might not be fully accounting for the number of cuts needed. The Bank’s cautious stance is backed by the cooling inflation trends. The latest CPI report for August showed headline inflation dropping to 2.8%, which is manageable. This indicates that the Bank can prioritize growth over inflation in its future decisions.

Divergence with US Policy and Currency Impact

This creates a distinct difference between Canadian and US policies, which signals potential weakness for the Canadian dollar. The Federal Reserve is still suggesting a higher-for-longer approach, which should push the CAD down due to the widening rate gap. The impact of tariffs on Canadian exports, reminiscent of the trade disputes in 2023, adds to our bearish view on the CAD. Given the uncertainty about when the next cut will happen, options strategies are particularly important. The Bank’s statement about not being “as forward-looking as normal” indicates it will react strongly to new data before the October meeting. This situation is ideal for buying calls on CORRA futures to prepare for a possible surprise cut if upcoming jobs or GDP reports disappoint. Create your live VT Markets account and start trading now.

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