May 15, 2025
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By Atul Oka, Senior Director of Strategy and Business Development, DUKE Heights BIA
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While the Canadian economy ended 2024 on a positive note with inflation trending near the Bank of Canada's (BoC’s) 2% target, and earlier interest rate cuts, which provided a stimulus to economic growth, this momentum has now been significantly challenged in 2025.
The unpredictability of the current global trade environment has made conventional economic forecasting unusually challenging, and the BoC has taken to outlining two illustrative scenarios instead of a single confident forecast for the Canadian economy. These scenarios explore the impact of the different potential evolutions of U.S. trade policy.
Scenario 1 – Low Tariff Path
Scenario 1 reflects a moderate, Low-Tariff path and assumes that the scope of actual tariffs implemented are limited and envisages a situation where most tariffs are eventually negotiated away or are significantly diluted.
Economic Impact
GDP
In this Scenario, the Canadian economy is projected to experience modest growth, with Gross Domestic Product (GDP) expanding from 1.5% in 2024 to 1.6% in 2025. Growth is then expected to dip slightly to 1.4% in 2026 before recovering to 1.7% in 2027. According to the Bank of Canada's analysis, GDP is anticipated to stall briefly in the second quarter of 2025 but then resume expansion at a moderate pace. Canada avoids a recession under this scenario.
Inflation
CPI is forecasted to decline below the 2% target for the remainder of 2025 and into early 2026, averaging around 1.5%. This dip is attributed to the combined effects of the removal of the consumer carbon tax and the prevailing excess supply in the economy.
Subsequently, inflation is expected to return to, and stabilize around, the 2% target. However, inflation for goods excluding food and energy is projected to be above its historical average in the second half of 2025 due to the impact of existing Canadian tariffs on some U.S. consumer goods and U.S. steel and aluminum, the delayed effects of the Canadian dollar's depreciation in late 2024, and businesses diversifying their supply chains to potentially higher-cost suppliers due to concerns about future tariffs.
Scenario 2 – High Tariff Path
This scenario outlines a far more severe trade war, involving tariffs of significant size and scope. It assumes that the uncertainty and limited tariffs described in Scenario 1 persist but are compounded by the addition of significant new U.S. tariffs.
Economic Impact
GDP
The impact on the Canadian GDP is more severe in this Scenario. Growth is projected to decline sharply from 1.5% in 2024 to just 0.8% in 2025, before contracting by 0.2% in 2026.
A rebound to 1.6% growth is anticipated in 2027.
Inflation
Inflation under this scenario is more complex and is expected to average close to the 2% target through the first quarter of 2026 as the disinflationary impact of the consumer carbon tax removal, and economic slack from the recession, roughly offset the initial upward pressure from tariffs.
However, as the full impact of the tariff’s filters through the economy, the banks analysis projects a rise to over 3% in the second quarter for 2026, then gradually decline back to 2% in 2027.
The Short-Term Outlook: Key Factors to Watch
The immediate future for the Canadian economy is contingent on several evolving factors, from fresh economic data to the Bank of Canada's policy responses and, most critically, the trajectory of international trade relations.
Recent data suggests that the economic headwinds anticipated by the Bank of Canada may already be materializing. The Labour Force Survey for April 2025 revealed that Canada's unemployment rate climbed to 6.9%, an increase from 6.7% in March. This marked its highest level in over three years and surpassed market expectations however the lagged effects of policy decisions and economic shocks mean that the full impact of announced tariffs and ongoing uncertainty will take time to fully filter through the economy. Thus, the situation could deteriorate further before being fully captured in official statistics, suggesting that these early signs of weakness might intensify.
Additional factors such as the erosion of consumer and business confidence may further translate into tangible decisions on spending, hiring, and investment.
The BoC will watch these key measures closely as it attempts to balance the possibility of negative GDP growth coupled with higher inflation, and will provide greater insight to policy guidance during the next
The BoC may offer clues to policy and their view on the Canadian economy, on June 4, 2025 (next scheduled announcement on the overnight rate), and on July 30, 2025 (next MPR).
