The Bank of Canada has lowered its overnight rate target by 25 basis points to 2.75%. The Bank Rate is now at 3.0%, and the deposit rate is 2.5%. Global economic conditions have changed, with rising US tariffs and uncertainty causing a slowdown in the overall economy. In the US, growth has slowed down. While business investment is strong, consumer spending is cautious, and job growth has decreased. US CPI inflation rose in June due to tariffs impacting consumer prices. The euro area is also seeing slower growth linked to US tariffs, and China’s growth is weakening because of reduced investment. Global oil prices are stable, and financial conditions have improved, evident in higher equity markets and lower bond yields.

Economic Conditions in Canada

In Canada, the economy is showing some strength, despite disruptions from US tariffs. The GDP dropped by 1.5% in the second quarter, and exports fell by 27% mainly because of lower demand from the US and ongoing trade uncertainties. Business investment dropped, and job losses in sensitive sectors pushed the unemployment rate up to 7.1%. As of August, CPI inflation was at 1.9%, with core measures ranging from 2.5% to 3%. High inflation in housing costs is beginning to decline, and the Canadian government’s removal of retaliatory tariffs may lower inflation pressures. Despite these economic difficulties, the Governing Council decided to keep the policy interest rate steady, although they might consider a cut if inflation pressures ease. The Bank of Canada’s decision to lower the overnight rate to 2.75% marks a notable shift, indicating that worries about economic weakness are now more pressing than inflation concerns. This could be the start of a trend toward lower rates, as the bank’s forecasts suggest that economic slack will continue until 2026. Overnight Index Swaps are pricing in over a 60% chance of another cut by December 2025, pointing to a clear trend for lower short-term rates. This policy change supports a case for shorting the Canadian dollar, especially against the US dollar. With US inflation rising and its economy slowing down rather than shrinking, the gap between monetary policies in the two countries is likely to enlarge. The USD/CAD exchange rate has already risen above 1.3800 on this news, and we expect it will reach highs not seen since 2023 as traders anticipate further Canadian weakness.

Impact on Trade and Investments

The 1.5% GDP drop in the second quarter of 2025, driven by a 27% plunge in exports, presents a grim outlook for trade-focused sectors. This decline is worse than expected and suggests that uncertainty will add to market volatility. We are preparing for this by investing in options on the S&P/TSX 60 index, as Canada’s volatility benchmark, the VIXC, has already spiked above 22. With the labor market weakening and the unemployment rate reaching 7.1%, companies that rely on consumer spending will encounter challenges. This situation resembles the slowdown observed in the late 2010s, when declining consumer confidence preceded reduced discretionary spending. Therefore, we are utilizing derivatives to manage exposure to Canada’s consumer discretionary sector and focusing on defensive sectors that are less affected by the economic cycle. Create your live VT Markets account and start trading now.

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