On Monday, Bank of America (BofA) economists forecasted that the Bank of Canada (BoC) will reduce its overnight policy rate target by 25 basis points on January 29, setting the rate at 3%.

The anticipated move is based on the expectation that the BoC will then signal a pause to observe the effects of domestic activity and US trade policy developments.

According to BofA, with inflation largely in check and an expectation for continued improvement in economic activity, the new rate is seen as the terminal rate. Furthermore, BofA's US economists predict the US Federal Reserve will maintain its rates throughout the year.

However, the report notes a potential deviation from this forecast if the US implements tariffs on Canada, which could prompt the BoC to lower rates further to leverage the Canadian dollar as a protective measure.

The economists also revised their Canadian rates forecasts while acknowledging the possibility that tariffs could lead to lower rates if the market begins to price in further cuts. The end of the BoC's quantitative tightening (QT) is now expected in August 2025, with settlement balances projected to be between CAD$50 billion and CAD$70 billion.

For foreign exchange implications, BofA sees 1.42 as the initial target level for the USD/CAD exchange rate. They also suggest that confirmation of tariffs could push the USD/CAD beyond the 1.45 resistance level, potentially reaching between 1.50 and 1.55 if the BoC adopts a dovish stance.

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