Sluggish growth and subdued inflation means more Bank of Canada easing

Summary

Canada's economy appears to have slowed noticeably in late 2024, and prospects are mixed as 2025 begins. The outlook for the household sector is somewhat resilient given firming growth in real incomes, and with interest costs set to decline further in the months ahead. In contrast, sentiment in the corporate sector remains downbeat, while declining profitability could also act as a headwind to business investment.

Adding to this mixed outlook are increased uncertainties related to U.S. tariff policy and local politics. Our working assumption is that many U.S. imports from Canada may face a tariff of around 5% from the middle of this year. Prime Minister Trudeau's recent resignation should result in a period of uncertainty and transition, even if it eventually leads to a more stable government. These tariff and political uncertainties should offer further headwinds to exports and investment spending.

Considering the mixed outlook and prevailing uncertainties, we forecast only a modest pickup in Canadian GDP growth to 1.7% in 2025 from an estimated 1.3% in 2024, with the risks tilted toward an even slower recovery.

Combined with sub-trend growth, contained overall inflation should allow the Bank of Canada to keep lowering policy interest rates at the next several meetings. Domestically oriented inflation is starting to slow more noticeably and, while wages are still elevated relative to productivity, labor cost pressures are also easing.

We expect the Bank of Canada to cut rates by 25 bps in January, March, April and June, taking the policy rate to 2.25%, which would be at the lower end of the perceived neutral policy rate range. Sluggish Canadian growth, lower Canadian interest rates, and cautious Federal Reserve easing is also likely in our view to keep the Canadian dollar broadly on the defensive over the medium term.

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