Published on: October 30, 2025
As expected by the markets, the central banks of Canada and the United States cut their respective policy rates by 25 basis points on Wednesday. The Bank of Canada (BoC) overnight rate is set at 2.25%, while the target range for the US federal funds rate stands between 3.75% and 4%.
BoC Decision
The Canadian central bank justifies its recent decision by citing the current weakness of the economy. It also believes that its decision should play a part in keeping inflation close to the 2% target while helping the economy through a “period of structural adjustment.”
In his opening statement, Governor Tiff Macklem nevertheless tempered his optimism by explaining that the trade dispute still represents a significant drag on the country’s economic outlook. “The structural damage caused by tariffs reduces our production capacity and leads to additional costs, which limits the ability of monetary policy to stimulate demand while keeping inflation low,” he explains.
Here are some observations made by the BoC in its most recent Monetary Policy Report:
Is the BoC Downplaying Supply Shocks Too Much?
It should be noted that the Bank of Canada’s growth forecasts for consumption are generally more pessimistic than necessary. The central bank also tends to systematically overestimate productivity. In fact, the average hourly earnings of prime-age workers are outpacing total inflation by more than a percentage point. The only occurrence of this phenomenon dates to the period preceding the global financial crisis. Wage growth already exceeds total inflation, even without considering hours worked.
The BoC’s analysis also appears to focus primarily on non-labour costs, such as shipping costs and the impact of US tariffs. That said, in a service economy, wages are by far the largest input cost, which has a significant impact on inflation when business margins are very low, as is the case in Canada. The share of labour costs dominates all other costs in the total production cost.
Lastly, there is once again a certain inconsistency between the BoC’s statements and its actions. The Senior Deputy Governor made it clear yesterday that now is not the time to “add an inflation problem to a trade problem.” The crux of the matter is whether it makes sense to push the policy rate to the lower end of the neutral rate range using a tool that affects aggregate demand, given that the Canadian economy is primarily affected by supply shocks. While export demand has been impacted, considering all the shocks, the supply side is dominating. This is evidenced by the 8% gap in labour productivity relative to its long-term trend and the fact that 90% of the increase in the unemployment rate can be explained by labour supply rather than a decline in employment.
Fed Decision
The US Federal Reserve (the Fed) cited the slowdown in the labour market and inflationary pressures as the reasons behind its decision to cut its key interest rate to its lowest level in three years. It also points out that the economy is growing at a moderate pace and that the unemployment rate remains low, while noting that “risks to employment have increased in recent months.”
At a press briefing, Fed Chairman Jerome Powell said that US central bank officials were struggling to reach a consensus on future monetary policy and that financial markets should not anticipate further interest rate cuts at the end of the year. “During the committee’s discussions at this meeting, there were widely differing views on how to proceed in December,” he explained.
The Fed’s announcement was not supplemented by an update of its economic forecasts. The new economic projections and timely data will be released on December 10.
Here are some key points regarding this decision:
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Inflation has risen since the beginning of the year and remains relatively high.
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The Fed also announced the end of its reduction of global securities positions on December 1.
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Yesterday’s decision was made despite opposition from two members.
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The FOMC projected two interest rate cuts for 2025 last December.
Under the Shadow of the Shutdown
The bond market reacted sharply yesterday when the Fed Chair stated shortly after the decision that the December meeting was not a certainty. This statement is linked to the suspension of federal government services, as the lack of data is prompting the Fed to be more cautious. Although this short-term residual effect is a consequence of the shutdown, the central bank’s reaction took almost everyone by surprise. Looking at the prices for upcoming meetings, we see that the December 10 meeting now has a federal funds rate of 3.725%, up from 3.62% yesterday. The Fed’s decision in December, if any, will depend on the length of the shutdown and the economic indicators available at that time.
Chair Powell spoke at length about the US labour market. He said that in the absence of official data, the Fed was looking at initial unemployment claims in the states. As there is not much movement in this area, the Fed concluded, based on this data and other factors, that the US labour market situation was roughly a “stable situation.”
According to Mr. Powell, there has been a “dramatic” decline in the labour supply in the United States, to the point where the new threshold for stabilizing the unemployment rate was virtually zero in terms of job creation. Admittedly, job creation is less significant than before, but the unemployment rate has just exceeded the Fed’s long-term estimates. This is the ideal indicator for determining whether the supply of labour is growing more slowly than labour demand. Recent data indicates that the unemployment rate in the United States has just reached a new cyclical peak. This means, by definition, that there are more unemployed people than job openings.
The Fed must therefore continue to lower its rates if it wants to avoid a further increase in unemployment unless new data changes the situation when the government shutdown ends.