Policy Moves Align, Outlooks Diverge: Bank of Canada and Federal Reserve Lower Rates

Both the Bank of Canada and the U.S. Federal Reserve lowered their policy rates by 25 basis points today, but despite the symmetry in timing and magnitude, the decisions reflect different economic conditions and policy priorities. For investors, particularly those managing fixed-income or cross-border portfolios, the implications extend beyond the headline moves, with yield differentials, inflation expectations, and currency movements all in play.

The Bank of Canada brought its overnight rate down to 2.25%, citing a slowdown in domestic demand and growing slack in the labour market. Canada’s inflation rate came in at 2.4% year over year in September, slightly higher than forecast but still close to the Bank’s 2% target. Core inflation measures remained around 3% , with underlying price pressures near 2%, indicating that inflation is moderating but not yet fully resolved. Labour-market conditions have softened, with the unemployment rate at 7.1% in September. The Bank noted that hiring intentions have weakened and that job losses over recent months have been concentrated in trade-sensitive sectors. GDP growth projections have been revised lower, with the economy expected to expand by about 1.2% in 2025 and 1.1% in 2026, highlighting the persistence of weak momentum. 

In the United States, the Federal Reserve lowered the federal funds target range to 3.75%-4.00%. U.S. headline inflation increased up to 3% in September from 2.9% in August, while core inflation also registered 3%, a slight improvement from 3.1% the previous month. The labour market has continued to cool, with the unemployment rate around 4.3% higher than earlier in the year, though still significantly lower than in Canada. The Fed noted that economic activity moderated in the first half of 2025, but consumer spending and wage growth have remained more resilient. Despite the rate cut, the Fed is maintaining its balance-sheet reduction program, which continues to tighten financial conditions through long-term yields. This suggests that while the central bank is willing to ease slightly to prevent an unnecessary rise in unemployment, it remains cautious about the persistence of inflationary pressures.

The impact of these policy moves is being felt most clearly in the shape of each country’s yield curve. In Canada, short-term yields have begun to respond to the BoC’s easing, with the two-year yield falling while ten-year yields remain relatively stable—producing a modest steepening of the curve. This reflects expectations of continued easing combined with limited long-term inflation risk. In the United States, the yield curve remains inverted in the short-to-intermediate segment, with two-year yields still higher than ten-year yields. Beyond the ten-year point, however, the curve has begun to re-steepen, with the thirty-year yield now exceeding shorter maturities. This partial inversion suggests that markets are still pricing in near-term economic softness and additional policy easing, while acknowledging longer-term inflation or funding pressures that are keeping long-end yields elevated.

Source: World Government Bonds. “Canada Yield Curve Data.” Accessed on October 29, 2025

Source: U.S. Department of the Treasury. Daily Treasury Par Yield Curve Rates. Accessed on October 29, 2025

Looking ahead, the Bank of Canada emphasized that with ongoing weakness in the economy and inflation expected to remain close to its 2 percent target, the current policy rate is appropriate to support the economy through this period of structural adjustment while keeping inflation near target. In contrast, the U.S. Federal Reserve is earlier in its cutting cycle, having just begun to lower rates, and markets anticipate further reductions through the first half of next year as inflation pressures ease and growth slows. According to WIRP data, markets are pricing only a 21% probability of another rate cut in Canada at the December meeting, compared with an 87% probability of a rate cut in the United States, highlighting the divergence in policy expectations between the two central banks.

World Interest Rate Probability - Source: Bloomberg - October 29, 2025

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