The Bank of Canada is navigating a complex economic landscape as it prepares for its first interest rate announcement of the year on Wednesday. Pressures are mounting on multiple fronts, from concerns over inflation to the looming threat of a trade war with the United States.

Inflation Signals and Economic Challenges

Recent data shows persistent inflationary pressures that could justify maintaining higher borrowing costs. Core inflation, measured by the three-month moving average, remains above 3%, despite December’s headline inflation cooling to 1.8%, partly due to temporary government tax relief.

However, fears of economic disruption are intensifying. U.S. President Donald Trump has reiterated his intention to impose 25% tariffs on Canadian imports, potentially triggering a recession in Canada. Economists warn that such tariffs, if implemented and sustained, would severely impact economic growth.

Stephen Brown, Deputy Chief North America Economist at Capital Economics, notes that a trade war of this scale could leave Canada with few options. “If Trump follows through with these tariffs, a recession would be inevitable,” Brown says.

Balancing Rate Cuts and Currency Risks

The central bank is under pressure to ease interest rates further to support growth amid these challenges. Since 2024, the Bank of Canada has reduced its policy rate by 1.75 percentage points, bringing it to 3.25%. Markets widely expect a smaller rate cut of 25 basis points this week.

However, cutting rates too aggressively could weaken the Canadian dollar further, making imports more expensive and adding to inflationary pressures. With the U.S. Federal Reserve signaling a potential pause in rate cuts, the divergence could amplify currency risks.

Tariff Uncertainty Weighs on Investment

Even the threat of tariffs is already creating economic headwinds. Canadian businesses are holding back on investment, reflecting growing uncertainty. According to a recent survey by the Bank of Canada, two in five firms reported negative impacts from U.S. trade policies.

Economists like Benjamin Reitzes, BMO’s Managing Director for Canadian Rates and Macro Strategy, highlight that the tariff threats alone are enough to justify further rate cuts. “It makes sense to cut rates by 25 basis points, even if inflation data doesn’t strongly support it,” Reitzes says.

The Path Ahead

The central bank’s outlook for 2025 remains uncertain. While economists anticipate at least three additional rate cuts this year, bringing the policy rate to 2.5%, much will depend on the trajectory of U.S. trade actions and global economic conditions.

If the U.S. Federal Reserve limits its rate cuts amid a resilient economy, the Bank of Canada may also opt for a more cautious approach. Conversely, the implementation of tariffs could force steeper cuts to counter the economic fallout.

The Bank of Canada is set to release its updated monetary policy report on Wednesday, alongside its rate decision, providing further insights into its strategy for the year ahead.

For more insights into Canada’s economic outlook, visit Global News.