Outlook

The trade conflict has made the outlook for the Canadian economy highly uncertain. There is a range of scenarios for how US trade policy could unfold, which leads to a wide range of outcomes for Canadian inflation and economic growth.

Rather than focusing on a single, highly uncertain projection, this Report presents two illustrative scenarios for how US trade policy could unfold. These scenarios are designed such that, when taken together, they encompass a range of trade policies (see the Assumptions for the outlook scenarios section).

These two scenarios encompass a wide range of economic outcomes. Inflation in Canada could remain around or below target or temporarily rise above 3%. Growth of gross domestic product (GDP) could stall for one quarter, or there could be a significant recession that permanently lowers the standard of living in Canada (Table 2 and Table 3).

Scenario 1

Trade policy uncertainty weighs on activity. GDP stalls briefly in the second quarter of 2025 and then expands at a moderate pace, resulting in persistent excess supply.

Inflation drops below target for the rest of 2025 and in early 2026 due to both excess supply in the economy and the removal of the consumer carbon tax. This occurs despite the upward pressure on prices from the few remaining tariffs. Inflation then averages around 2% for the rest of the scenario horizon.

Economic activity

GDP growth stalls in the second quarter of 2025 (Chart 13). It then averages around 1.6% through the end of 2027. This pace of growth is only slightly stronger than that of potential output, leaving the economy in modest excess supply.

Export growth drops

Exports fall sharply in the second quarter of 2025 after two strong quarters during which trade was pulled forward in anticipation of US tariffs. Foreign demand for Canadian exports weakens considerably, particularly from the United States, due to the impact of the limited tariffs and trade policy uncertainty.

Export growth then picks up from the second half of 2025 into 2027.1 The completion of new export capacity for liquefied natural gas in mid-2025 and the increased use of the Trans Mountain pipeline support exports.

Import growth also declines sharply in the second quarter of 2025 after Canadian businesses pulled forward their purchases of US goods ahead of anticipated tariffs. Following this initial drop, import growth recovers, led by a measured improvement in spending on consumption and in business investment.

Final domestic demand expands modestly

Growth in final domestic demand is weak in the near term before expanding at a moderate pace over the rest of the scenario horizon. Consumption is subdued in the near term as households build up precautionary savings due to concerns about their future employment prospects and wealth. While these effects are most prominent for households employed in export-oriented industries, they spill over to the broader economy. Quarterly consumption growth is modest for the rest of 2025 and then slowly strengthens in 2026 and 2027.

Businesses remain uncertain about the strength of demand. As a result, business investment is sluggish, contracting in the second quarter of 2025. Growth in business investment then picks up through 2026 and 2027 as the impact of uncertainty fades.

Inflation

Consumer price index (CPI) inflation initially slows due to the removal of the consumer carbon tax (Chart 14). Inflation then rises to about 2% and stays at that level.

The removal of the consumer carbon tax lowers CPI energy prices. This pulls down CPI inflation by 0.7 percentage points for one year, to average about 1.5% (see In Focus: How removing the consumer carbon tax affects inflation).

Inflation in goods excluding food and energy is above its historical average in the second half of 2025. This strength is due to:

• Canada’s tariffs on some US consumer goods as well as on US steel and aluminum imports
• the delayed effects of the depreciation in the Canadian dollar in late 2024
• businesses’ concerns over possible future tariffs, which encourage them to diversify their supply chains to higher-cost suppliers

As these pressures diminish, modest excess supply in the economy leads to a slowdown in goods price inflation as well as softer inflation in the other CPI components.

Scenario 2

Canada’s GDP contracts over the next year due to tariffs and the adverse effects of uncertainty. Growth gradually recovers to around 1.8% in 2027.

Inflation averages close to 2% through the first quarter of 2026. The removal of the consumer carbon tax and ongoing economic slack roughly offset the impact of tariffs. Inflation then rises above 3% in the second quarter of 2026 due to the impact of tariffs. It then gradually declines to the 2% target in 2027.

Economic activity

The broad trade war severely impacts Canadian households and businesses, precipitating a year-long recession. GDP contracts for four quarters, with growth averaging about -1.2% (Chart 15). It then gradually recovers throughout the rest of 2026 and 2027. US tariffs permanently reduce Canada’s potential output and its standard of living (see Appendix: Potential output and the nominal neutral rate of interest).

Trade is drastically reduced by tariffs

Exports fall sharply until the middle of 2026. The contraction is mainly due to US tariffs on imports from Canada and a slowdown in global economic activity (see the Global economy section).

Export growth resumes in the third quarter of 2026 but remains weak. Tariffs permanently reduce US demand for Canadian products, and it takes time for businesses to find new export markets.

Imports contract until the middle of 2026 for many of the same reasons as exports. Import growth then increases as domestic demand rebounds.

Domestic demand stalls

The impacts of tariffs on trade spread to the rest of the economy. Growth in final domestic demand stalls over the second and third quarters of 2025. It then slowly recovers.

Canadian exporters reduce production and lay off workers. This, in turn, leads to a rise in unemployment, a drop in real incomes and a slowdown in economy-wide household spending.

Lower global commodity prices lead to a decline in Canada’s terms of trade, which further reduces households’ purchasing power. Tariffs also make imported items more expensive for consumers.

Overall, consumption falls slightly in the second and third quarters of 2025 and then expands modestly through 2026. Growth in consumption gradually strengthens in 2027 as the unemployment rate slowly declines.

Business investment declines significantly due to weak economic activity, particularly in the export sector, and the impact of persistent uncertainty. A lower Canadian dollar raises the cost of imported equipment and machinery, which further weighs on business investment. Growth in investment turns positive in late 2026 and picks up in 2027.

Inflation

CPI inflation averages around 2% until early 2026 (Chart 16). It then rises above 3% because of upward pressure on prices coming from tariffs. Inflation returns to the 2% target in 2027.

Inflation averages about 2% until the first quarter of 2026. This reflects opposing forces. Downward pressures include the effect of removing the consumer carbon tax and the disinflationary impact from excess supply. Upward pressures include the effects that tariffs and supply chain disruptions have on prices of imported goods.

As the effect of removing the carbon tax ends, inflation rises and reaches a peak of 3.1% in the second quarter of 2026. It then gradually returns to the 2% target in 2027. The easing in inflation is due to persistent excess supply in the economy and the fading impact of tariffs on prices of imported goods.

Tariffs put temporary upward pressure on inflation

The tariffs that Canada imposes on US goods are estimated to affect roughly 9% of Canada’s CPI basket (for details on the included tariffs, see the Assumptions for the outlook scenarios section). It is assumed that three-quarters of the increased costs from tariffs will be passed through to consumers over six quarters. Once prices have adjusted to their new level, the rate of inflation normalizes.2 Moreover, the Canadian dollar depreciates to 67 cents US, and US tariffs drive up the costs of some US goods that are used as inputs to production in Canada. Canadian businesses reorganize their supply chains to help reduce the impact of higher import costs.

The rise in costs mostly affects the prices of goods excluding energy. Inflation in food prices and in prices of goods excluding food and energy rises sharply over the next year. Thereafter, inflation in these categories slows gradually.

Excess capacity weighs on inflation

US tariffs and persistent uncertainty cause a significant slowdown in Canadian economic activity. Although potential output is also lower, considerable excess capacity emerges as workers and capital are displaced.

The output gap reaches about -1.7% in the first quarter of 2026 and then narrows somewhat over the rest of the scenario horizon. Excess supply in the economy exerts downward pressure on inflation over the entire scenario horizon. This pressure is most apparent in prices in the services sector, which are not directly boosted by tariffs.

Endnotes