Canadian Interest Rates: Navigating the Final Descent to the Neutral Floor

The Canadian financial landscape is traversing a critical six-month window, stretching from late 2025 into early 2026. This period is defined by the Bank of Canada’s (BoC) cautious pivot toward monetary easing, a necessary response to domestic economic slowing. For investors, realtors, and homeowners, understanding the anticipated path of both variable interest rates, controlled by the BoC, and fixed interest rates, governed by bond markets, is crucial. Analysis suggests that while variable rates are nearing their structural floor, fixed rates will be constrained by powerful fiscal headwinds.

I. The Current Monetary Crossroads: Tipping the Scales in October 2025

A. Setting the Stage: The Policy Rate at 2.50% and the Easing Imperative

The Bank of Canada recently signaled a decisive shift in its monetary stance, cutting its policy rate to 2.50% on September 17, 2025.¹ This reduction was driven primarily by a negative economic outlook characterized by sluggish Gross Domestic Product (GDP) growth and rising unemployment.¹ This action confirmed the central bank's transition from an active tightening phase to one of measured easing. However, the speed and magnitude of subsequent cuts remain highly dependent on incoming economic data, especially inflation and labor market trends.²

B. Assessing the Odds: The Critical October 29th Decision

The immediate focus is the BoC’s upcoming scheduled rate announcement on October 29, 2025.³ Market expectations, derived from Overnight Index Swaps (OIS), indicate a finely balanced decision, with the odds of a 25 basis point rate cut currently sitting at 59%.⁴ This narrow margin reflects significant market uncertainty and highlights the internal conflict within the BoC's governing council.

The case for immediate easing hinges on weak domestic demand. Results from the Bank’s Business Outlook Survey illustrate that firm outlooks and intentions remain "subdued," with investment plans described as "restrained".⁵ Consumer confidence has also deteriorated, evidenced by a drop in job-finding prospects for various sectors.⁵ This pervasive economic inertia suggests that the central bank’s prior rate hikes have successfully dampened aggregate demand. To avoid an unnecessary recession and combat rising unemployment, immediate stimulus through a rate cut is strongly indicated. Furthermore, this weak demand environment constrains firms’ ability to pass rising input costs, such as those derived from tariffs, onto consumers, thereby limiting one major channel of inflation.⁵

Conversely, the argument for pausing centers on persistent inflationary pressures. Although headline CPI growth tracked around 2.3% year-over-year in September, underlying core inflation measures continue to hover near 3%.² This core inflation reading sits significantly above the central bank’s mandated 2% target.⁶ The persistence of core inflation suggests that domestic, non-commodity price pressures—such as services inflation or wage growth—are not yet fully extinguished. Cutting rates immediately, while core inflation is still sticky, risks prematurely relieving these pressures and potentially unanchoring longer-term inflation expectations, which could necessitate a return to tightening later. Thus, the October decision represents a high-stakes gamble on whether the weak growth data will decisively outweigh the stubbornly high core inflation readings.

Table 1 summarizes the key factors influencing the immediate decision.

Table 1: Key Data & October 29th Decision Factors

Indicator	Current Reading/Value (Oct 2025)	Policy Implication
Market Odds (OIS)	59% Rate Cut Probability	High Uncertainty / Inflection Point
Core CPI (YoY Tracking)	Near 3.0% (Above Target)	Constraint on Easing
Business Outlook/Investment	Subdued / Restrained	Mandate for Easing
Policy Rate (Current)	2.50%	Near Neutral Rate Range

II. Dissecting the Bank of Canada’s Rationale: The Trade Uncertainty Multiplier and the R-Star Anchor

A. The Structural Threat: Tariffs and Policy Volatility

A critical factor complicating the Bank of Canada’s decision-making is the highly volatile US trade policy environment. Tariffs are significantly higher now than they were at the beginning of 2025, and their ultimate trajectory is extremely difficult to predict.⁶ The threat of trade escalation introduces a massive external risk premium into the Canadian economy.⁷ Modeling by the BoC shows that in a scenario where trade negotiations deteriorate, economic growth slows markedly while inflation rises to around 2.5% in 2026 due to increased costs.⁸

This presents the central bank with a complex policy dilemma, sometimes referred to as stagflationary pressure: tariffs simultaneously slow economic growth due to uncertainty and restrained investment ⁵ while raising input costs (inflation). The Bank must decide whether to prioritize combating the slowdown by cutting rates or prioritizing price stability by holding rates firm against cost-push inflation. By moving toward easing, the BoC appears to be betting that weak domestic demand will be sufficient to absorb some of the tariff-related price pressures.⁵ Should trade uncertainty escalate further, however, the forecast for a rate floor could be invalidated, potentially forcing the BoC to pause or even reverse cuts.⁸

B. Defining the Bottom: Anchoring Policy to the Neutral Rate (R-Star)

To understand where variable rates are likely to settle, one must consider the Bank of Canada’s estimate for the nominal neutral rate, or R-star. This is the theoretical interest rate that neither stimulates nor restricts the economy when inflation is stable at the 2% target. The Bank assesses the Canadian nominal neutral rate to be in a range of 2.25% to 3.25% in 2025.¹⁰

This R-star range provides the structural and intellectual foundation for the consensus rate floor forecast. Since the Canadian economy, while facing challenges, is not currently in a deep financial crisis or a prolonged deflationary spiral, the BoC’s objective is to normalize rates to this neutral level. The lower bound of this assessed range, 2.25%, therefore represents the highest probability floor for the policy rate.¹⁰ A move below 2.25% would signal a commitment to aggressively stimulating the economy, an action unwarranted by the current resilience provided by Canadian financial institutions and the systemic buffer of mortgage stress tests.¹²

III. The Six-Month Trajectory: Consensus and the Path to 2.25%

A. The Major Bank Consensus: A Shallow Easing Cycle

Across Canada’s major financial institutions, a remarkable degree of consensus exists regarding the immediate trajectory of the policy rate. Economists at TD Economics, CIBC, Scotiabank, and National Bank all anticipate the BoC policy rate falling to 2.25% by the end of 2025 or early 2026.⁹ This unity confirms the market expectation that the bulk of the necessary monetary tightening is complete, and only 25 to 50 basis points of easing remain in this cycle.

The timing of this final descent to 2.25% hinges primarily on the October 29th decision. If the cut proceeds, the rate floor is reached immediately, suggesting the central bank will enter a prolonged pause throughout Q1 2026 to assess the full impact of easing and tariff risks. If the BoC pauses in October to monitor stubborn core CPI readings ², the market will anticipate the final 25 basis point cut to occur in December 2025 or January 2026, pushing the floor slightly later into the six-month window. In either scenario, the ultimate destination remains 2.25%.

Table 2 illustrates the widespread agreement among forecasters.

Table 2: Major Canadian Bank Policy Rate Forecasts (Q4 2025/Q1 2026)

Institution	Forecast (Policy Rate Floor)	Timing
TD Economics	2.25%	Q4 2025
Scotiabank	2.25%	End of 2025
CIBC	2.25%	End of 2025 or Early 2026
National Bank	2.25%	End of 2025
BoC R-Star Lower Bound	2.25%	Structural Floor

IV. The Fixed Rate Challenge: Forecasting Government of Canada Bond Yields

The trajectory of fixed-rate lending, such as 5-year fixed mortgages, is determined not by the BoC’s overnight rate, but by yields on long-term Government of Canada (GoC) marketable bonds. Currently, GoC 5-year yields are trading around 2.65% to 2.69% ⁹, maintaining a relatively tight spread over the current policy rate of 2.50%.¹

A. The Fiscal Headwind: Record Bond Supply vs. Monetary Easing

The most significant constraint preventing fixed rates from falling sharply is the increasing fiscal pressure exerted by the Canadian government. The government’s debt management strategy projects a substantial increase in bond supply, with annual gross bond issuance planned at $316 billion in fiscal year 2025-26, up sharply from $241 billion in 2024-25.¹⁴ This increase is necessitated by large and persistent federal deficits, which may push into the mid-$70 billion range.¹⁵

This supply dynamic creates technical upward pressure on bond yields. The market must absorb a massive quantity of new GoC debt, thereby increasing the technical risk premium demanded by bond buyers. This counters the downward gravitational pull typically exerted by an easing central bank. In a typical easing cycle, 5-year bond yields often lead the BoC lower in anticipation of future cuts. However, the high supply shock counteracts this anticipatory behavior. The result is a partial decoupling: while the variable overnight rate falls toward 2.25%, fixed rates are capped from falling much below 2.50%. Fixed mortgage rates are, therefore, expected to bottom out slightly higher and potentially sooner than the variable rate.

B. External Influences and Currency Risk

Further complicating the bond outlook is the divergence in monetary policy between Canada and the United States. The US Federal Reserve is projected to maintain a much higher target rate of 3.6% by the end of 2025 ¹⁶, contrasting sharply with the BoC’s expected 2.25% floor.⁹ This widening interest rate differential, or "wedge," exerts pressure on the Canadian dollar (CAD) against the US dollar (USD), as investors move capital across the border seeking higher relative returns.⁷

A weaker Canadian dollar acts as a partial brake on the BoC's easing efforts by making imports more expensive, risking the re-importation of inflation.⁷ This external risk implies that GoC bond yields cannot fall too aggressively without triggering currency instability that jeopardizes the 2% inflation target. Consequently, GoC 5-year yields are expected to see only marginal declines over the next six months, constrained by fiscal supply risk and currency pressures, settling in the 2.50%–2.75% range.

Table 3: Government of Canada Benchmark Bond Yields: Current Snapshot & Forecast

Tenor	Current Yield (Mid-Oct 2025)	6-Month Forecast Range (Q1 2026)	Primary Driver
Policy Rate (Overnight)	2.50%	2.25%	BoC Monetary Easing
5-Year GoC Bond	$\sim 2.65$	2.50% – 2.75%	Fiscal Supply Constraint
10-Year GoC Bond	$\sim 3.07$	3.00% – 3.25%	Term Premium & Inflation Expectations

V. Real Estate Repercussions: Navigating Mortgage Renewal Shock

A. The Great Renewal Wave: A Structural Constraint on Consumption

The easing cycle, while providing relief to the margin, must be contextualized against a massive structural risk: the mortgage renewal wave. Approximately 60% of all outstanding Canadian mortgages are scheduled to renew in 2025 and 2026.¹⁷ This represents a significant financial shift for the majority of the country’s homeowners.¹⁷

For homeowners holding five-year fixed-rate mortgages, the implications are stark. Those renewing in 2025 or 2026 could face an average monthly payment increase of around 15%–20% compared with their payment levels in December 2024.¹⁸ This is because even with policy rates easing to 2.25%, they remain significantly above the ultra-low rates prevalent when these mortgages were first signed.

Conversely, variable-rate holders who have variable payments are finally projected to see some relief. Based on expected rate cuts, their payments are forecast to decrease by 5%–7%.¹⁸ However, those with variable-rate, fixed-payment mortgages (VRFP) face wide uncertainty, with a small segment potentially seeing payment increases exceeding 40% as their amortization periods are reset in 2026.¹⁷

This mandatory adjustment in household debt service acts as a powerful, non-monetary, deflationary mechanism. The 15%-20% payment shock guarantees that households will be forced to curtail discretionary spending.¹² This involuntary reduction in aggregate demand provides a persistent long-term tailwind for the BoC's ability to keep the rate floor at 2.25% without triggering sustained upward pressure on inflation.

Table 4 details the forecasted impact of the renewal wave.

Table 4: Projected Mortgage Renewal Payment Impact (2025-2026)

Mortgage Type	Targeted Impact	Average Payment Change (vs. Dec 2024)
5-Year Fixed Rate	High-Risk Renewals	+15% to +20%
Variable Rate (Variable Payment)	Immediate Relief	-5% to -7%
Variable Rate (Fixed Payment - High Shock)	Tail Risk	>+40% increase (10% of renewals)
Total Mortgages Renewing	Financial Stability Focus	60% of outstanding mortgages

B. Systemic Resilience and Market Dynamics

Despite the scale of the payment increases, the risk of a system-wide financial failure, such as mass forced sales, remains low. The BoC notes that over 90% of fixed-rate mortgage holders renewing were stress-tested at the time of origination, implying their budgets were assessed to accommodate payments higher than the current anticipated renewal rates.¹² Furthermore, Canadian financial institutions continue to demonstrate strong financial resilience, sufficient to absorb the potential materialization of key risks.¹⁹

On the market activity front, the initial interest rate cuts have already provided a boost to previously sluggish demand. Prospective buyers are re-entering the market as fears of economic collapse ease and lower interest rates gain traction.²⁰ This suggests a modest, gradual recovery in home resale activity is likely in the second half of 2025, setting a firmer base for 2026.²⁰ However, regulatory bodies have cautioned that the condo market, particularly in the Greater Toronto Area (GTA) and Greater Vancouver Area (GVA), remains under pressure and shows signs of deterioration.¹⁹

VI. Strategic Implications and Actionable Recommendations

The next six months will solidify the new reality of Canadian interest rates: a lower but structurally elevated normal, anchored by the neutral rate.

A. For Investors and Fixed Income Positioning

Investors should recognize the policy floor at 2.25% for variable rates, meaning further significant gains from duration are limited. Given the massive GoC bond supply shock projected for 2025-26 ¹⁴, which constrains long-end yields, positioning should favour the "belly" of the bond curve (3- to 7-year maturities).¹⁶ These maturities are poised to benefit from expected policy rate cuts while minimizing exposure to the concentrated sovereign supply risk at the long end.

B. For Realtors and Market Guidance

Realtors should guide clients with the expectation that rates have reached their floor for the foreseeable future. The market is entering a normalization phase where rates are low enough to gradually restore buyer confidence ²⁰ but will remain above pre-pandemic levels. Critical emphasis must be placed on proactively preparing fixed-rate clients renewing in 2026 for the anticipated 15%–20% payment spike ¹⁸ to ensure smooth transactions and mitigate renewal risk.

C. For Homeowners (The Fixed vs. Variable Decision)

The data provides a clear trade-off:

1. Variable Rate Path: Homeowners who choose a variable rate now are positioning themselves to capture the final 25 basis points of expected easing, achieving immediate payment relief as the rate hits the consensus 2.25% floor.⁹ This strategy requires tolerating short-term volatility and the risk that trade tariffs could briefly halt or reverse the easing cycle.⁶

2. Fixed Rate Path: Given that fixed rates (GoC yields) are constrained by fiscal supply and are unlikely to fall significantly below the 2.50%–2.75% range ¹⁴, locking in a fixed rate now offers certainty near the bottom of the current fixed-rate cycle. This choice buffers the homeowner against both external tariff-related inflation risk and broader sovereign supply pressure.