Monetary Policy Report—January 2025
Global economic growth remains near 3%, and headline inflation is close to central bank targets in many countries. However, uncertainty has increased amid political and trade tensions. The outlook does not incorporate new tariffs threatened by the United States.
The outlooks for inflation and global growth are broadly in line with the October Report (Chart 18; Table 3 in the Projections section). However, these outlooks are subject to greater uncertainty than normal. This uncertainty is due to US President Donald Trump’s threat to impose significant import tariffs (Chart 19). As well, several major economies are experiencing heightened political uncertainty.
In this context, developments in financial conditions have been mixed across countries. Markets expect fewer US policy rate cuts, and long-term US interest rates have edged up. Many advanced economies have seen their currencies depreciate against the US dollar.
Chart 18: Total inflation is near target, but inflation excluding food and energy remains elevated in many major economies
Year-over-year percentage change, monthly data
Sources: Statistics Canada, US Bureau of Economic Analysis and Eurostat via Haver Analytics, and Bank of Canada calculations
Last observations: United States, November 2024; others, December 2024
United States
US economic growth is expected to remain robust in 2025 and to moderate in 2026. Solid growth in labour income and past increases in financial wealth continue to boost consumer spending. Inflationary pressures in core services are persisting, and inflation in the United States has ticked up slightly, although it is expected to ease in 2025.
The projection assumes that the Tax Cuts and Jobs Act will be extended. Other assumptions about US fiscal policy remain unchanged.
US growth is strong but expected to moderate
US growth is estimated to have averaged 2.9% in the second half of 2024 and is expected to decline gradually to a still-solid pace of around 2.3% in 2026. Consumer spending, which has been surprisingly strong, is underpinning growth (Chart 20).
Solid growth in household income and past gains in financial wealth continue to support consumer spending in 2025. The anticipated extension of provisions of the Tax Cuts and Jobs Act is expected to boost household spending into 2026. By the end of the projection, the pace of consumption growth is forecast to soften slightly to about 2.2%.
Growth is anticipated to slow over the projection for state and local government spending as well as for business infrastructure investment due to the fading effect of past federal incentives.
The US economic outlook is subject to greater uncertainty than usual. The new US administration has proposed lower personal and corporate income taxes, changes to regulatory and immigration policies, and wide-ranging tariffs. (See In focus: Evaluating the potential impacts of US tariffs.)
US services price inflation remains elevated and declines only gradually
US inflation, measured by the personal consumption expenditures price index, is estimated to have edged up in the fourth quarter of 2024 to about 2.4%. This rise is mainly due to additional upward pressure from inflation in prices for core services (Chart 21). Over the projection, inflation gradually eases as demand growth slows and shelter price inflation subsides.
Inflation in services prices is estimated to have remained elevated at about 3.8% in the fourth quarter of 2024 due to strong consumer demand and because some prices have been slow to adjust to past cost increases. As these prices adjust and domestic demand growth slows, inflation in services prices is expected to come down. In addition, easing growth in house prices and recent declines in new tenant rents are expected to reduce shelter inflation over time. Inflation in goods prices is expected to rise from its low level as the impact of past declines in prices for durables fades.
Further into the projection, inflation in the United States moves close to target, with the economy growing at a pace broadly in line with potential output.
Chart 21: PCE Inflation in services prices remains above pre-pandemic levels
US PCE inflation, year-over-year percentage change, monthly data
Sources: US Bureau of Economic Analysis via Haver Analytics and Bank of Canada calculations
Last observation: November 2024
Euro area
Euro area gross domestic product is expected to grow at a subdued pace of around 0.8% in 2025 before gradually strengthening to about 1.3% in 2026. Economic growth is expected to be weighed down by ongoing weakness in manufacturing. The manufacturing sector is struggling to adjust to structural challenges, such as a lack of infrastructure investment and relatively high energy prices, along with persistent competitiveness pressures.
Financial markets expect the European Central Bank (ECB) to further reduce its policy interest rates. This policy easing should support domestic demand and boost consumer and business sentiment.
Inflation in the euro area is expected to be close to the ECB’s target of 2% over the projection. In particular, inflation in core services is projected to ease, reflecting modest growth in consumer demand, slowing wage growth and the dissipation of temporary effects related to sporting and cultural events in 2024.
China
Growth in domestic demand in China is projected to rise in the near term, bolstered by recent policy announcements. These announcements include spending vouchers for households, debt support for local governments and policies to stabilize the property sector. Exports grew at a rapid pace in 2024, mostly due to rising production capacity and falling prices for China’s manufactured goods. The prices of manufactured export goods are expected to stabilize, leading export growth to slow in 2025.
Later in the projection, economic activity eases as the impact of cyclical policy measures fades and structural challenges, such as an aging population, hold back growth.
Commodities
Oil prices have risen in response to tightened sanctions on Russian oil amid low global inventories (Chart 22). In addition, the Organization of the Petroleum Exporting Countries (OPEC) and OPEC+ members (OPEC plus some non-OPEC oil producers) have again delayed unwinding voluntary production cuts. Brent oil is assumed to average US$80 over the projection, higher than expected in the October Report.
The Bank of Canada’s commodity price index excluding energy is largely unchanged (see Changes to the projection in the Projections section).
Financial conditions
Many global central banks have continued to reduce their policy interest rates as inflation has moved toward their targets. However, recent data and possible policy changes under the new US administration have led market participants to expect greater divergence in economic outlooks across countries.
In this context, changes in financial conditions have differed across countries. In the United States, markets now anticipate fewer policy rate cuts and that those cuts will come later than previously expected. This is partly due to ongoing strength in the economy and persistent inflation. In addition, market participants have begun to place some weight on potential policy changes under the new administration and their likely economic implications. These factors have supported a strong rise in US sovereign bond yields. Bond yields in most other advanced economies have either modestly declined since October, as in Canada (Chart 23), or have risen by less than in the United States, reflecting weaker growth and inflation prospects.
Chart 23: US bond yields have risen whereas Canadian bond yields have modestly declined since the October Report
Last observation: January 27, 2025
Equity market valuations in advanced economies have continued to rise. Measures of risk appetite have generally remained strong, with equity risk premiums and corporate credit spreads still low relative to historical levels.
The US dollar has continued to appreciate against most other currencies and recently hit an all-time high on a nominal trade-weighted basis. The value of the Canadian dollar has fallen against the US dollar to about 70 cents US but has remained more stable against a basket of other currencies (Chart 24).
Most of the recent strength in the US dollar appears to be due to an increase in the foreign exchange risk premium associated with holding non-US currencies. While the spread between US and Canadian policy rates has increased, Bank models suggest this has had only a modest impact on the Canada-US exchange rate. (See In focus: Recent drivers of the Canada-US exchange rate.)