Dovish Inflation Reports Help Bank of Canada Rate Cut Odds, Says TD

06:56 AM EDT, 08/25/2025 (MT Newswires) -- TD said it has long believed that economic slack from a softening Canadian economy would help ease inflationary pressures, counterbalancing the upward push on consumer prices caused by retaliatory tariffs on United States goods, efforts to diversify exports away from the U.S., and Canadian firms seeking new suppliers.

The July inflation data aligned closely with this narrative, noted the bank. Headline inflation remained mild at 1.7% year-over-year, with the continued effects of the April carbon tax removal and falling gasoline prices weighing on the overall number-though gasoline prices are on track to stabilize in August.

More crucially, core inflation trends have shown encouraging signs of cooling, stated TD. The Bank of Canada's preferred measures of core inflation remained elevated on a year-over-year basis, but shorter-term momentum slowed notably.

On a three-month annualized basis, the average of the BoC's key metrics (CPI-Median and CPI-Trim) eased to 2.4%, the slowest pace seen in nearly a year. Similarly, more traditional core measures -- CPI excluding food and energy, and CPIX -- both dropped by over one percentage point to about 2.2%. These trends prompted a market reaction, with both bond yields and the Canadian dollar slipping, and modestly raised expectations for a possible BoC rate cut at the Sept. 17 meeting.

Even with the CPI report, markets are still only assigning a 33% chance of a rate cut at the September meeting. The BoC has a chance to review another round of jobs and inflation data before its next rate announcement, pointed out the bank.

This week's Q2 gross domestic product report is also highly anticipated. TD predicts an annualized contraction of about 1.5%, signaling increased slack in the economy and adding further downward pressure on inflation.

This economic backdrop could pave the way for two more rate cuts this year, given that the current policy rate still sits at the midpoint of what the BoC considers neutral for the economy. Trade was the main drag on Q2 growth, with exports dropping due to softer U.S. demand -- amid tariffs -- and an unwinding of earlier gains prompted by anticipation of tariffs.

Despite an expected weak GDP report for Q2, the Canadian economy has shown more resilience than the bank expected a few months ago. Last week offered more glimpses of this durability, with July housing starts reaching their highest level since 2022, as the rental market is receiving a tailwind from powerful past population growth and government programs targeting this sector.

Meanwhile, retail sales volumes advanced 1.5% month-on-month, supported by gains in a broad range of categories. Encouraging as these results may be, significant uncertainty remains, added the bank.

Canada also continues to face tariffs and a notable slowdown in population growth. Reports indicate that some progress may come on the tariff front, with the Canadian government to remove some retaliatory tariffs on U.S. goods to restart stalled trade talks.

However, in the near term, these factors remain in play, and the economy will be hard-pressed to generate strong momentum in Q3, according to TD.

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