Will Interest Rates in Canada Drop in 2025?
Capital-B Insights | December 14, 2024
Written by Miguel Laursen
A Simple Guide to Understanding Interest Rates in Canada
Interest rates impact everything from mortgages to the overall economy. For Canadians, whether you’re a homeowner, investor, or buyer, understanding how these rates work is key. In this article, we’ll break it down and look at whether 2025 might bring lower rates and how that could affect you.
Key Highlights
- Interest Rates and Inflation: The Bank of Canada adjusts interest rates to control inflation, aiming to keep it at a stable 2%.
- Current Rate and Projections: The current policy rate is 3.25%. Experts predict rates could gradually decrease to 2.50% in 2025.
- Why Rates Change: Higher rates curb borrowing and spending to control inflation, while lower rates encourage economic growth.
- Impact on Canadians: Lower rates may reduce mortgage payments, encourage homebuying, and boost real estate investment, but tight housing supply will likely keep prices and rents high.
- Gradual Changes Ahead: Any rate cuts in 2025 are expected to be slow and cautious, depending on economic conditions.
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What You Need to Know
- The Bank of Canada (BoC) sets interest rates to control inflation and stabilize the economy.
- Inflation, housing demand, and immigration are key factors influencing these rates.
- Experts predict a gradual decrease in rates during 2025, but changes will depend on how the economy performs.
How Do Interest Rates Work?
The Bank of Canada uses its policy rate to manage inflation:
- If inflation is high: Rates go up to slow borrowing and spending.
- If inflation is low: Rates are lowered to encourage borrowing, spending, and growth.
Currently, the BoC’s rate is 3.25%, which means borrowing costs—like mortgages—are higher than they’ve been in recent years. This is to help keep inflation under control.
Are We Heading for Record-High Rates?
No. Canada’s highest-ever rate was 22.75% in 1981. While today’s rate is far below that, the cost still feels steep for many because of how much housing prices and household debt have increased.
As housing prices have soared, so have mortgage sizes. Even small changes in interest rates can now make a big difference in monthly payments. In cities with high demand for housing, this makes affordability a real challenge.
What’s the Link Between Inflation and Interest Rates?
The Bank of Canada aims to keep inflation around 2%.
- If inflation is high: It eats away at your purchasing power, and the BoC raises rates to cool spending.
- If inflation is low: It signals weak demand, so rates are lowered to encourage spending and investment.
This balancing act is why interest rates change. Lowering rates helps the economy grow, but raising them is necessary to control rising prices.
Will Rates Drop in 2025?
Experts predict that interest rates will start to decrease in 2025, potentially reaching 2.50% by the end of the year. This is within what economists call the “neutral range” (2.25% to 3.25%), where rates neither boost nor slow the economy too much.
The process, however, will likely be slow. The Bank of Canada will take careful steps to ensure inflation doesn’t climb again. In some cases, the rates might even stay the same for a while, depending on how the economy performs.
How Will Lower Rates Affect You?
If rates drop, it could be good news for many Canadians:
- Homeowners: Your monthly mortgage payments might decrease if you’re on a variable rate.
- Buyers: Lower rates make borrowing cheaper, which might make buying a home more affordable.
- Investors: More people could enter the market, boosting demand for properties.
However, housing supply is still tight, and demand is growing due to immigration. Even if rates go down, home prices and rents are likely to stay high.
Frequently Asked Questions
Why does the Bank of Canada target a 2% inflation rate?
The BoC aims for 2% inflation because it balances economic growth with price stability. Higher inflation erodes purchasing power, while lower inflation may signal weak economic activity. A steady 2% helps businesses and consumers plan for the future with confidence.
How does the CAD-USD exchange rate affect interest rates in Canada?
The value of the Canadian dollar compared to the U.S. dollar (CAD/USD exchange rate) can influence inflation and, in turn, interest rates. A weaker CAD makes imported goods more expensive, adding inflationary pressure. To manage this, the Bank of Canada may raise rates to keep inflation under control. Conversely, a stronger CAD can reduce inflationary pressure, potentially allowing for rate cuts.
Why are housing prices still high even when rates are high?
High rates generally cool demand by making borrowing more expensive. However, in Canada, tight housing supply and growing population pressures are keeping home prices elevated. Even if rates drop in 2025, supply constraints may continue to push prices upward.
How do interest rates affect the overall economy?
Higher interest rates discourage borrowing and spending, slowing down economic growth to control inflation. Lower rates, on the other hand, stimulate borrowing and spending, which boosts economic activity but can increase inflation if not managed carefully.
What’s Next?
The Bank of Canada’s decisions on interest rates are crucial for homeowners and investors alike. While a drop in rates is expected, the exact timing and size of the decrease will depend on how inflation and the economy evolve.
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