What Lies Ahead for the Canadian Economy in 2025?

Canada’s inflation rate has cooled, but the journey to economic recovery in 2025 remains fraught. Most notably, Donald Trump’s threatened tariffs and a devaluing Canadian dollar could continue to hinder the nation’s economic growth in the new year.

The November Consumer Price Index report showed that while headline inflation of 1.9% was near the Bank of Canada’s 2% target, core inflation measures remained stubbornly high in key areas of the economy. Market analysts expect receding inflation and growing slack in the Canadian economy have created more room for the Bank of Canada to consider further cuts in 2025.

Inflation Trends

The latest CPI numbers highlighted that travel prices and slowing mortgage interest costs (a direct consequence of the interest rate cuts) did the bulk of the heavy lifting in keeping inflation tame and on target. The mortgage interest cost component “has eased from nearly 30% inflation in 2023 to 13% year over year in the latest report,” says PIMCO economist Tiffany Wilding. Meanwhile, price increases were most visible in energy-related categories and shelter components. Overall, she thinks the report supports the view that the economy still struggles.

Moreover, there are still latent inflationary forces to contend with. “One worrying sign for the Bank of Canada is a slight acceleration in rent prices, after a promising slowdown in the October report,” points out Jules Boudreau, senior economist at Mackenzie Investments. “We also saw the Bank’s preferred measures of core inflation rise at about 3.5% monthly pace in November.”

Core inflation measures (which exclude volatile components like food and energy prices) remain a key concern for 2025. Some of these measures, such as trim inflation (up 2.7%) and median inflation (up 2.6%), stayed obstinately high in November, well above the central bank’s 2.0% target.

The latest CPI report marks the first of two inflation reports that the Bank of Canada will assess before its next rate decision on Jan. 29. This will be a crucial meeting as the central bank shapes its approach for the coming year.

What CPI Figures Reveal About the Economy

Boudreau says the fact that inflation has dropped so quickly in Canada despite the inflationary forces still in play is a testament to the weakness of the country’s economy, especially compared with other advanced economies. The weak labor market (6.8% unemployment rate), low growth, and weak consumer confidence are expected to continue as underlying factors in 2025.

“Canada teetering on the brink of a recession is partly due to the Bank of Canada’s rate-hiking cycle [last year], which is reflected as deflation in many consumer goods,” says Boudreau. “As long as the Canadian economy keeps flirting with a recession and the job market continues to deteriorate, it’s unlikely we’ll see inflation jump back to the rates we saw in 2022 and 2023.”

Notably, inflation’s biggest impact on the Canadian economy was visible in the real estate sector. “While many homeowners have been getting relief from lower mortgage rates, renters are still feeling the heat,” Boudreau says, stressing that rents climbed 7.7% between November 2023 and November 2024, a jump from the 7.2% year-over-year number in October.

Wilding sees rental inflation easing in 2025, though, as immigration slows in the next year and “asking rents have fallen into outright deflation.” Traveler accommodation inflation, which soared to nearly 9% year over year in November (as Taylor Swift’s Eras Tour swept through Canada), is also expected to ease.

The weaker-than-expected November inflation print was also a function of moderation in prices of consumer goods, such as clothing and appliances. “This partly reflects weak consumer sentiment amid a slowing economy,” says Boudreau. “Retailers had to offer higher-than-usual discounts in November, which includes the Black Friday shopping window, to attract consumers.”

There are fears that a falling loonie could cause a spike in goods inflation. However, that hasn’t materialized yet, “with clothing, car purchases, and furniture all experiencing deflation,” says Wilding.

The impact of loonie depreciation is already visible in food prices, rising at a pace slightly above the pre-covid trend. “The significant drop in the value of the Canadian dollar explains a portion of the 2.7% increase in food prices over the past year,” says Boudreau.

Gasoline prices have broadly remained steady as oil prices have traded toward the bottom of the multi-year range. “This has provided relief to consumers but also weighs on economic growth in oil-producing provinces,” Boudreau says.

Inflation Trajectory and Bank of Canada’s 2025 Rate Moves

Carl Gomez, chief economist and head of market analytics at CoStar Group Canada, argues the Canadian economy is operating with a fair degree of slack, and that the Bank of Canada still has scope to ease further in early 2025.

However, federal stimulus from the tax holiday and rebate checks, as well as the risk of US President-elect Donald Trump’s proposed tariffs raising prices of goods, may begin to fuel inflation down the road. “As a result, the Bank is likely to deliver a more conventional cut [of 25 basis points] in January to err on the side of caution,” he says.

Wilding says that following 175 basis points of cuts in 2024, the data supports a slowdown in the pace of rate cuts moving forward. “Further, easing should come as inflation remains in the Bank of Canada’s target band, and the unemployment rate is climbing higher,” she says, adding that while there have been some signs of stronger consumption and housing market data, “the recovery is still in early days.”

The latest inflation data is unlikely to sway the Bank of Canada from its plans for the January rate decision. “Officials already wanted to shift down to 25-basis-point cuts [in 2025],” Boudreau says. “Nothing in this CPI report would cause the Bank to deviate from that plan.”

What the CPI Report Means for Markets

Gomez sounds a cautionary note for Canadian investors about the fallout from Trump’s potential tariffs when he takes office on Jan. 20. Long-term bond yields are increasingly concerned about global inflation risks from potential protectionist US trade policies. “Long-term bond yields remaining somewhat elevated is resulting in risk spreads remaining thin for many asset types, [including] stocks, corporate bonds, and real estate,” he says. It is due to the uptick in bond yields that long-term interest rates have resisted falling in response to the Bank of Canada cuts and “even have some upward bias,” Gomez explains.

Boudreau cautions investors about the implication of the weaker loonie for their unhedged investments: “We expect the Canadian dollar to remain weak, as we see the Bank of Canada cutting rates all the way down to 2% in the third quarter of 2025. Investors can take advantage of [the loonie] weakness by avoiding fully-hedged investments.” He recommends exposure to foreign currencies, which could provide portfolio diversification and extra returns for Canadian investors if the loonie falls further.

In addition to the uncertainty surrounding trade relations with the US, which will present a considerable downside risk in the coming year, “investors should remain wary of the growth headwind that will come from slowing immigration flows,” cautions Wilding.

The demographic shifts from slower immigration in 2025 and beyond could weigh on the housing market, dampen retail consumption, and tighten labor market dynamics, all of which carry significant implications for investment strategies moving forward.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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