Monetary Policy Report—January 2025
The prospect of wide-ranging US import tariffs is the most important risk to the outlook. Given the fast-evolving situation and the high degree of uncertainty, the Bank has chosen not to include new tariffs in the projection.
Risk of tariffs
US President Donald Trump has threatened to impose tariffs on major US trading partners, including a 25% tariff on imports from Canada and Mexico. Affected countries, including Canada, could respond with tariffs of their own. The scale, breadth and duration of a potential trade war is uncertain. Even if all these details were known, it would be difficult to predict with precision how the effects would flow through the economy. The magnitude and timing of the impacts will depend importantly on how businesses and households respond to higher prices for inputs and final goods.
A permanent—or at least prolonged—broad-based and significant increase in tariffs, together with retaliation, would have a substantial negative impact on economic activity in Canada. At the same time, inflation would likely increase, due to higher costs for imported final and intermediate goods. In the face of a trade conflict, the response of monetary policy must balance the downward pressure on inflation from excess supply in the economy with the upward pressure on inflation from new tariffs on imports.
A detailed discussion of the channels through which the Canadian economy would be affected by tariffs, including an illustrative scenario, can be found in the section In Focus: Evaluating the potential impacts of US tariffs.
Apart from the imposition of wide-ranging tariffs, the Bank’s outlook for inflation is subject to several upside and downside risks. Overall, the Bank views these risks to inflation as roughly balanced.
Main upside risks
There are two main upside risks: shelter price inflation could be more persistent than in the projection, and consumer spending could be stronger than anticipated.
Shelter price inflation could persist
Inflation in shelter prices is expected to slow gradually. However, because the housing vacancy rate is near a record low, past interest rate cuts and the recent changes in mortgage rules could lead to higher-than-anticipated house prices and rents. As a result, shelter price inflation and total inflation may slow more gradually than anticipated.
Consumer spending could be stronger
Canadians are saving a relatively higher share of their income than they typically did over the past two decades. With interest rates falling, however, the savings rate could return closer to historical levels. This could result in consumer spending that is significantly stronger than anticipated. If this risk were to materialize, it would create additional demand in the economy and place upward pressure on inflation.
Main downside risks
Even if no new tariffs are imposed, the threat of tariffs is creating uncertainty, which is already having a negative impact on the Canadian economy. The effect of this uncertainty could be bigger than expected. Another downside risk is that global financial conditions could be tighter than anticipated.
Trade uncertainty could weigh more on the economy
Responses to several surveys show that, even without tariffs being imposed, the uncertainty about trade policy is restraining business investment intentions. Reflecting this development, the outlook includes a modest negative impact on business investment.
There is a risk, however, that the impact of uncertainty could be larger than currently embedded in the projection. The longer this uncertainty persists, the more it would negatively impact investment. Businesses could also cut back on hiring, which would weigh on labour income and consumer confidence. Consequently, domestic demand would slow, exerting downward pressure on inflation.
Global financial conditions could be tighter
The new US administration has proposed additional personal and corporate tax cuts that are not included in the projection. Given the high level of US debt and deficits, an increase in US government borrowing could lead to higher-than-anticipated yields. Higher yields in the United States could, in turn, spill over into higher borrowing costs for Canadian households and businesses. This would lead to weaker Canadian domestic demand and add downward pressure on Canadian inflation.