Current conditions

Inflation remains close to 2%, and past cuts in interest rates are boosting economic growth in Canada. At the same time, the threat of wide-ranging tariffs by the new US administration has increased uncertainty.

Quarterly growth in gross domestic product (GDP) is estimated to have been about 1.4% in the second half of 2024. The labour market is still soft, and the economy remains in modest excess supply. Spending has begun to increase on housing and on goods and services that are sensitive to interest rates.

Consumer price index (CPI) inflation has remained around 2% in recent months, as expected in the October Report.

Economic activity

GDP growth slowed to 1% in the third quarter, weaker than anticipated at the time of the October Report. It is estimated to have increased modestly to around 1.8% in the fourth quarter (Chart 1).

Growth in final domestic demand has been solid and is estimated to have climbed to about 3.5% in the fourth quarter. This recent strength reflects continued robust growth in consumer spending and a pickup in residential investment. In contrast, business investment remains weak.

Uncertainty has risen in recent months because the new US administration has threatened to impose wide-ranging tariffs on Canada and many other major US trading partners. In Canada, there are signs that this uncertainty is weighing on consumer and business confidence and on investment intentions. The threat of new tariffs has also contributed to the recent decline in the Canadian dollar relative to the US dollar (see In focus: Recent factors affecting the Canada-US exchange rate).

Final domestic demand growth has been solid

The latest data available indicate that growth in final domestic demand was solid in the fourth quarter, led by growth in consumption per person and a surge in residential investment (Chart 2). This suggests that households are responding to lower interest rates. In contrast, growth in government spending has moderated, and business investment has remained flat.

Growth in consumption per person turned positive in the third quarter of 2024, and it is estimated to have increased further to about 1.6% in the fourth quarter. This rise is supported by cuts made to the policy interest rate in 2024 and robust growth in disposable income per person.

Residential investment is estimated to have increased sharply by about 15% in the fourth quarter of 2024 (Chart 3). Continued strong growth in home resales—which boosts ownership transfer costs—and a substantial rise in new home construction were supported by lower interest rates and pent-up demand. In contrast, renovation activity remained soft.

Business investment has been weak and is estimated to have remained flat in the fourth quarter (Chart 4).

While government spending growth was strong through much of 2024, it is estimated to have eased in the fourth quarter, in line with plans laid out in federal and provincial budgets and fiscal updates.

Exports rise in the near term

Exports were weak over the first three quarters of 2024 despite the strength in foreign demand. While part of this weakness likely reflects ongoing competitiveness challenges, temporary factors are also at play. These include short-term shutdowns at some Canadian and US motor vehicle facilities.

Export growth is estimated to have risen sharply to around 4.6% in the fourth quarter, mostly reflecting a surge in the exports of gold and pharmaceuticals, which tend to be highly volatile. This recent pickup also reflects the re-opening of some motor vehicle facilities, and export growth in the fourth quarter is further supported by increased oil exports.

Import growth is estimated to have increased to about 2.9% in the fourth quarter. This reflects a rebound in motor vehicle imports, partially offset by weak imports of machinery and equipment, which are restrained by subdued business sentiment.

Capacity pressures

The Canadian economy continues to be in modest excess supply. The output gap is estimated to be between -1.25% and -0.25% in the fourth quarter, roughly unchanged from the third quarter. Due to upward revisions to the level of GDP, there is slightly less excess supply than at the time of the October Report (see Changes to the projection in the Projections section). A broad suite of labour market data indicate ongoing labour market softness (Chart 5).

The labour market remains soft

The unemployment rate is somewhat higher than it was at the time of the October Report, with youth and newcomers continuing to be the most affected. Employment gains picked up, while the rate of increase in the working-age population slowed (Chart 6). In recent months, average job gains were strong enough to maintain the ratio of employment to the working-age population.

While wage growth remains sticky, the most recent data show some signs that it has begun to moderate. The slowing is most evident in private-sector wage growth. All wage growth leads to higher demand and, because of this, has some effect on inflation. However, the cost of producing consumer goods and services is most affected by private sector wages. Measures of private sector wage growth based on data from the Labour Force Survey (LFS) have moved closer to growth in private sector compensation per hour in the national accounts (Chart 7). Growth in LFS private sector wages slowed to 3.4% in December, down from 4.6% at the time of the October Report. The microdata-based measure of LFS private sector wage growth, which adjusts for compositional changes, declined to 3.4% in December from 4% in September.

The moderation in wage growth has reduced the risk that inflation in some services could prove to be more persistent than expected (see the Risks section of the October 2024 Monetary Policy Report).

The Bank judges that underlying inflation is close to 2%. There are no signs that inflationary pressures are broad-based. The share of CPI components rising by more than 3% is now below its historical average. Inflation expectations have largely returned to normal.

Inflation has remained around 2%

CPI inflation remains close to 2%. Shelter services price inflation is the only major component above its historical average (Chart 9). In particular, inflation remains elevated for rent and mortgage interest costs, but it has been easing.

At the same time, inflation in other major CPI components has generally been below historical averages. In addition, the GST/HST holiday is pulling down inflation over the near term, particularly in categories such as food services and semi-durable goods. By March 2025, the tax holiday will have ended, and inflation in these categories will go back up.

Goods price inflation remains soft

Inflation in goods prices was -0.1% in December, in line with recent months. Excess supply and past easing in cost pressures continue to weigh on inflation for many goods prices. Moreover, the temporary GST/HST holiday reduced inflation in some goods, including food, alcohol, children’s clothing and toys. These factors were partially offset by the recent depreciation of the Canadian dollar, which has had a small inflationary impact on the prices of imported goods.

Services price inflation has eased

Inflation in services excluding shelter eased to 2% in December from 2.3% in September. The temporary GST/HST holiday pulled down inflation in services excluding shelter, especially food services.

Inflation in shelter services eased to 5.1% in December, down further from 5.8% in September. This easing has been driven by slower growth in rent and mortgage interest costs. While recent data suggest that the average asking price for rents declined in December, rent inflation remains persistently elevated. The persistence of rent inflation mostly reflects a gradual and ongoing adjustment to past increases in new rents (see In focus: How the frequency of price changes affects inflation in the October Report).

CPI-median and CPI-trim remain above 2% largely because of the impacts of persistently high shelter inflation on the distribution of price changes.1 Chart 10 shows the distribution of inflation in December 2024 compared with its historical norm (from 1995 to 2019). The distribution of non-shelter components (Chart 10, blue lines) has largely returned to its historical norm. In contrast, shelter price inflation (Chart 10, yellow lines) is still being pushed up more than usual by components that are well above 2%.

Inflation expectations have almost returned to normal

Inflation expectations of both consumers and businesses have almost returned to normal (Chart 11). Consumers’ expectations eased further in the fourth quarter, and three-quarters of businesses now expect inflation to be between 1% and 3% at all horizons.

Endnotes