Heightened policy uncertainty in Canada amid an escalating trade conflict has lowered growth prospects and raised concerns about supply chain disruptions, and negative impacts on business investment, unemployment and consumer spending. The table below summarizes the changes to our outlook based on changes in tariff policies.

_{Source: Vanguard Research}

Business sentiment in Canada, as measured by the Future Option Index, fell below the neutral mark, pointing to how firms, on average, anticipate a reduction in production volumes relatively soon. Consumer confidence reached its lowest level on record as economic certainty weighed on job market growth. The labour market also experienced a significant decline in full-time work and short-term inflation expectations rose.

This comes on the heels of positive momentum for the Canadian economy in the fourth quarter of 2024 as headline inflation was near target, seven consecutive rate cuts by the Bank of Canada (BoC) stimulated economic activity and there was renewed momentum as GDP rose by an annualized rate of 2.6%, well above expectations.

Given heightened uncertainty and a murky outlook, even the BoC found it difficult to project a base case in April 2025 due to the high variability of outcomes. 

Our base case assumes an average 10% across the board tariff on Canadian goods by the U.S. with retaliation from Canada. This is similar to the current tariff rate of 8% which assumes full compliance with USMCA along with adherence to proof of origin rules.

We foresee inflation ending 2025 at 2.4%, moderately above our earlier expectation of 2.2%. This change is reflective of greater uncertainty and potential for increasing tariffs between Canada and the U.S.  We’ve also adjusted our 2025 forecast GDP for Canada down to 1.3%, as tariffs and global uncertainty  weigh on growth expectations. We anticipate that unemployment will increase to 7.0% by year-end.  A lower growth scenario will incentivize the BoC to cut rates further, down to 2.25% by year-end, although as the governor pointed out, monetary policy unlike fiscal policy, is not targeted to support the hardest-hit workers and businesses.

Monetary Policy

The Bank of Canada (BoC) decided to hold its policy rate at 2.75% on April 16, after seven consecutive rate cuts. Although the “uncertainty tax” has already shown signs of impacting the Canadian labour market and business investment, a 2.9 per cent year-over-year increase in CPI-median data in March, one of the BoC’s preferred measures of inflation, coupled with uncertainty around the economic outlook from U.S. tariffs, gave the central bank reasons to pause rate cuts.

The BoC indicated that they would proceed carefully as there as no clarity about which goods will be tariffed, what the rate would be, what would be negotiated and when. The governor also mentioned that he wanted to ensure inflation remained under control, likely referring to the risk from prices of services ex-shelter, which have risen. Medium and long-term inflation expectations remain anchored despite an over one percent surge in year-ahead inflation. A recent appreciation of the Canadian dollar which lowers the cost of import prices, likely also weighed on the BoC April hold.

We expect the BoC to cut to 2.25% by year-end, the lower end of their neutral rate. The lower growth scenario will incentivize the BoC to cut rates further despite higher pass-through to inflation. The BoC officials have been clear about monetary policy being a “blunt instrument” that supports or restricts demand across the entire economy. Fiscal programs are “much more targeted” to support the hardest-hit workers and businesses. Therefore, we don’t anticipate the BoC lowering policy rates below 2%.

Another reason why we expect further rate cuts is due to the output gap. As the Figure 1 shows, growth is expected to remain below trend and tariffs will lower Canada’s potential GDP as Canadian exporters will face lower demand from US consumers and businesses, which comprise 75% of Canadian exports. As Canada’s potential growth falls so will its neutral rate, therefore a 2.25% policy rate will be more restrictive relative to the time prior to the  imposition of tariffs.

Figure 1: Growth expected to remain below trend

_{Source: Vanguard Research}

Inflation 

We foresee core inflation at 2.4% at year-end 2025, above the midpoint of the BoC’s 1%-3% target. Canada’s headline inflation in March slowed to 2.3%, a 30-bps decline from February, largely driven by lower gasoline and travel tours prices. However, the BoC’s preferred measures of inflation, CPI-median an CPI-trim, both stayed elevated leaving the annual rates at 2.8% and 2.9%, respectively.

We see inflation rising by 40 bps from our earlier forecast partly due to retaliation on U.S. exports by Canada on what is currently $60 billion of Canadian counter-tariffs on U.S. goods. However, a rise in policy uncertainty has lowered our inflation forecast by 20 bps. Recently, Canadian households have raised their savings rate and cut discretionary spending, whereas business are increasingly focused on liquidity preference and balance sheet strength. A recent strengthening of the Canadian dollar has tightened financial conditions and also negated some of the impact of the higher prices of U.S. goods imported into Canada. The pass-through rate of inflation will be a critical factor. Most employers have indicated in survey data that they intend to pass on all or almost all higher costs due to inflation. Additionally, as businesses look to other substitute suppliers, their costs will rise.

Looking ahead, headline inflation is expected to experience downward pressure as the carbon tax was removed on April 1. This should negate some of the impact of higher tariffs temporarily. A loosening job market, a weak real estate sector and subdued demand for travel are also helping lower inflation. Services inflation is a metric that receives heightened focus from the BoC declined in March, partly due to a decrease in shelter inflation.

In figure 2, we see the components of Canadian headline inflation and their weighted contribution. We see that shelter price’s contribution to CPI has declined since September 2024 and food inflation had a small negative contribution to CPI once the GST/HST tax holiday began on December 14, 2024.

Figure 2: Shelter and food inflation’s contribution to Canadian CPI

_{Source: Bloomberg}

GDP Growth

We expect GDP growth to be 1.3% for 2025, based on our previously mentioned tariff assumptions. We believe that the “uncertainty tax” is impairing the Canadian labour market and business investment and will result in 0.25% lower growth for the year. Additionally, tariffs and retaliation coupled with softer U.S. growth will lower growth by another 0.25%. Lower exports by Canada will result in weaker terms of trade and reduce potential GDP as excess supply is created in the short run.

The eventual outcome from the 90-day pause of the reciprocal tariffs remains uncertain. Canadian autos received a 30-day pause only to be reinforced. There is substantial uncertainty for businesses that are negatively impacting growth. The Economic Policy Uncertainty Index for Canada soared to 1,542, nine times its historical average.

Economic activity in Canada had been strong in the last two quarters, with an annual growth number of 2%, triggered largely by seven consecutive interest rate cuts that boosted consumer confidence and investment. 

Currently, U.S. tariffs have targeted specific Canadian goods. Steel, aluminum and non-USMCA compliant goods are tariffed at 25%. Additionally, there is also a 25% tax on vehicles, only on the portion that is not made in the U.S. There are also 10% tariffs on energy and potash with tariffs on pharmaceuticals, copper and semiconductors likely to be implemented soon. The U.S. is also likely to more than double its duties on lumber to almost 35%.

These tariffs will have a negative impact on final domestic demand, slowing business and residential investment and consumer spending. The consumer confidence index fell to 44.2% in March, its lowest level in history. Figure 3 shows Canadian economic momentum is worsening, although leading indicators still point at trend growth, partly due to a frontloading of tariffs, which increased by 7.5% during the first quarter of 2025, in anticipation of tariffs.

Figure 3: Economic momentum is worsening

_{Source: Vanguard research}

Labour Markets

Uncertainty around tariffs and their implementation has resulted in many firms pausing hiring coupled with an increase in layoffs. Unemployment rose to 6.7% in March despite slowing population growth. Driven by a sharp decline in full-time work, the country shed over 30,000 jobs, mostly concentrated in the cyclically sensitive private sector. Sectors most impacted by tariffs such as automobile manufacturing and wholesale trade could contribute to a significant rise in unemployment. The automobile sector employs 125,000 people directly and 90% of Canadian made cars are shipped to the U.S. Food and chemical manufacturing are other sectors that are more impacted by tariffs.

Soft data reveals that Canadians are taking longer to find a job, are concerned about job security and overall intend to curb spending, largely due to uncertainty. Another sign that the labour market is cooling is lower wage growth which declined to 3.5% in March, down from 4.0%. There is concern about some exporters going bankrupt, fears exacerbated by a strengthening Canadian dollar, and potential for a widening output gap due to excess supply, both of which will drive unemployment higher. We expect year-end unemployment to be 7.0%.

Figure 4 shows the employment rate, the proportion of working-age population that is currently employed, has been falling as youth unemployment remains elevated. 

Figure 4: Canada employment statistics

_{Source: Vanguard research}