On the Radar: This Week's CPI Drop Boosts Odds of Bank of Canada Rate Cuts by Year-End

Capital Markets update
Aug 22, 2025

First National Financial LP

Quick Takes:

Headline CPI cooled to 1.7% in July, and the three-month core trend eased to about 2.4%.
Money markets see roughly 40% odds of a September 17 cut and price only one 25 bp move by the end of 2025.
With unemployment elevated and slack building, the base case is a later 2025 cut, while September remains a live, data-dependent option.

Canada’s latest inflation figures suggest price pressures are easing, and financial markets have responded by increasing bets that the Bank of Canada (BoC) could cut interest rates in the coming months. The July Consumer Price Index (CPI) report showed a notable cooling in inflation, strengthening the case for potential monetary policy easing before the end of 2025.

Inflation Eases in July, Led by Cheaper Gasoline

According to Statistics Canada, headline inflation slowed to 1.7% year-over-year in July, down from 1.9% in June. Declining gasoline prices largely drove this deceleration. With the removal of a federal carbon tax helping to keep fuel costs down, energy has been a major factor keeping overall inflation subdued. Every month, the CPI rose a modest 0.3% (seasonally adjusted +0.1%), in line with expectations.

At 1.7%, inflation remains comfortably below the midpoint of the BoC’s 1–3% target range. However, not all price increases have vanished: food and shelter costs continue to climb. Food prices rose 3.3% annually in July (up from 2.9% in June), and shelter costs, the largest component of the CPI basket, increased 3.0%, marking their first acceleration in over a year. Core inflation measures, which strip out volatile items, also remain sticky on an annual basis, hovering around the upper end of the target band (roughly 3% year-over-year). The BoC’s two preferred core indices (CPI-trim and CPI-median) were about 3.0–3.1% in July, indicating underlying inflation is still above the 2% goal.

Core Price Pressures Lose Momentum

Encouragingly for policymakers, underlying inflation momentum has started to slow. When looking at core inflation over a shorter horizon, there are signs of relief. Both the CPI-trim and CPI-median measures have eased to 2.4% on a three-month annualized basis, the lowest such core inflation pace since late 2024. In other words, although core prices are still higher than desired in year-over-year terms, their recent trend is downward. This metric is significant because the BoC closely watches three-month core trends as a gauge of where inflation is headed.

Analysts note that July was the first time in nearly a year that core inflation’s three-month average dipped below 3%. If this cooler core trend persists, it would signal that earlier interest rate hikes and emerging economic slack are taming price pressures. Indeed, some economists argue that if core inflation continues to run at an annualized 2.4% (or lower) and the economy remains soft, it will eventually set the stage for BoC cuts, In essence, the Bank of Canada could gain confidence that inflation is on a sustained path back to 2%, giving it room to reduce interest rates to support growth.

That said, risks remain. A sizable share of the consumer basket (over 37% of CPI components) is still seeing inflation above 3%, indicating broad-based price pressures have not completely vanished. Key essentials like food are rising faster than the headline rate, which could keep core inflation from falling quickly. The BoC will want to be sure that this recent moderation in core prices is not a one-off blip but part of a consistent trend. Any renewed uptick in underlying inflation – or one-off factors (e.g., tariffs or supply shocks) pushing prices up, could complicate the timing of rate cuts.

Market Reaction: Higher Odds of a Rate Cut

Investors reacted swiftly to the benign inflation data, adjusting their expectations for BoC policy. Money markets now assign roughly a 40% probability to a rate cut at the Bank’s next meeting on September 17, up from about 30% before the CPI release. In practical terms, traders have moved from viewing a September cut as unlikely to seeing it as a real possibility.

It’s worth noting that the Bank of Canada has kept its overnight rate at 2.75% for the past three policy meetings, after an earlier easing cycle. The current rate is significantly lower than it was a year ago (following a series of rate cuts in early 2025). Still, the Bank hit the “pause” button over the summer as it assessed whether inflation was cooling enough. Futures now effectively price in one 25 bp cut by the end of 2025, with little expectation of more than that in the near term.

Economic Slack is Building, Strengthening the Case to Ease

Beyond inflation figures, Canada’s economy is one of cooling growth and rising slack, which bolsters the argument for rate cuts. Labor market conditions have softened notably compared to last year. Canada’s unemployment rate edged up to 7.0% in May, its highest level (outside the pandemic) since 2016. In fact, since the start of 2025, there has been virtually no net job growth, according to Statistics Canada. Job gains have stagnated, and joblessness has been on an upward trend for several months. A looser job market usually cools wage growth and consumer spending, which in turn tends to dampen inflation.

The BoC itself has pointed to labour market evolution as a key input for policy. If unemployment continues to climb and economic output stays below potential (widening the output gap), the Bank will feel more comfortable that underlying inflation will continue to decline. Some analysts believe we are already seeing this dynamic: with hiring slowing and wage pressures easing, core inflation is losing steam. This was exactly the scenario the BoC had flagged as likely requiring “a further reduction in the policy interest rate”, essentially, a trigger for more cuts. Recent data on jobs, combined with the tame inflation prints, suggest that scenario is materializing.

Outlook: Will the BoC Cut Rates Again in 2025?

The big question now is when – or if – the Bank of Canada will pull the trigger on rate cuts in the coming months. After July’s CPI report, several Bay Street economists have updated their forecasts, but there is no unanimous view. In general, expectations can be grouped into a few camps:

September Rate Cut (Growing Chance): A contingent of economists now sees a real possibility of a 25 bp cut at the BoC’s next meeting on September 17, if upcoming data cooperate. The softer trend in core prices has removed one obstacle on the path to a rate cut in September. These analysts argue that with inflation cooling and the economy losing momentum, additional stimulus is warranted sooner rather than later. They note that another CPI release and employment report will come before the September decision; if those also show contained inflation and weakening job growth, the Bank could confidently ease. Current market pricing (40% odds) reflects this scenario being very much on the table.
Delayed Cut Later in 2025: Many forecasters expect the BoC to hold steady in September but cut rates a bit later in the year. Under this view, policymakers will likely wait for more confirmation of a sustained downtrend in core inflation (and perhaps evidence of a further economic slowdown) before acting. The Bank might use the extra time, through the fall, to ensure inflation is decisively headed to 2%. Even so, the consensus in this camp is that a one-quarter-point cut will occur by year-end (either at the October or December meeting). Financial markets are pricing in one 25 bp rate reduction by December, which implies an overnight rate of 2.50% by the end of 2025. This “one-and-done” easing outlook assumes the Bank will move cautiously. It’s a scenario in which the BoC resumes cutting rates in Q4 2025 once it has greater confidence that inflation (especially core measures) is sustainably back within its target range.
No Cut in 2025 (Hold Scenario): A minority of analysts maintain that the BoC may refrain from any further rate cuts this year if inflation doesn’t convincingly decline or if growth shows signs of resilience. From this perspective, the latest CPI dip to 1.7% is encouraging but not sufficient to justify more easing yet. Core inflation is still 3%, and the Bank has indicated it wants to see inflation “closer to 2%” before considering rate cuts. Some economists point out that the BoC already eased policy earlier in 2025 and might choose to stay on hold at 2.75% going forward unless inflation falls further. In their view, the Bank could very well skip a September cut and continue standing pat into 2026 if price and wage metrics don’t soften enough.

At this point, scenario 2 (a later 2025 cut) appears to be the baseline in markets and among many forecasters, with scenario 1 (September cut) seen as a distinct possibility if data stay benign, and scenario 3 (no cut) viewed as an outside chance.

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