A Gloomy Forecast for the Canadian Dollar in 2025

The Canadian dollar took many blows over the past year. Experts suggest that pain could persist in 2025.

Over 2024, the Canadian dollar fell nearly 8% against the US dollar, hitting a two-decade low of C$1.44 from C$1.33 at the start of the year. Currency watchers predict the loonie could weaken further in 2025, with projections ranging from C$1.45 to C$1.50. They point to a long list of weights on the currency heading into 2025:

A stubbornly high unemployment rateEconomic slackInterest rate cuts from the Bank of CanadaGrowing policy divergence with the US Federal ReserveConcerns about potential tariffs under the incoming Trump administration

“The Canadian dollar will struggle against the mighty greenback until Trump’s tariff thrusts are parried and the economy picks up,” wrote senior BMO Economics economist Sal Guatieri in a note to clients. Here’s what investors need to know.

US-Canadian Interest Rate Gap Weighs on the Canadian Dollar’s Outlook

Currency watchers identify the meaty gap between policy rates in the United States and Canada as one of the most concerning risks that could continue to put downward pressure on Canadian currency in the new year.

The Canadian central bank cut 175 basis points from its policy rate last year, compared with just 75 basis points of easing from its US counterpart. With the Bank of Canada’s interest rate sitting at 3.25% and the US Fed at a range of 4.25%-4.50%, the gap stands at a hefty 1.00%-1.25%.

However, there is optimism that a weaker loonie will have some positive effects on the broader economy. “Concern remains around monetary policy divergence with the US, [but] given the headwinds facing the Canadian economy, the divergence is justified and will likely come alongside some weakness in the Canadian dollar,” explains Desjardins macro strategist Tiago Figueiredo. “The hope is that currency weakness will help boost domestic economic activity and ultimately reduce the need for the central bank to further lower the policy rate.”

David Doyle, head of economics at Macquarie Group, predicts “policy rate divergence is likely to put further downward pressure on the loonie.” He forecasts that the loonie’s weakness will worsen to C$1.45 against the US dollar in the third quarter of 2025.

There is a real risk, though, that the US Fed will take an extended pause from cutting rates while the Bank of Canada continues easing monetary policy through 2025. Fed Chair Jerome Powell indicated after the December rate cut that the US central bank had entered a new phase, and that “we’re going to be cautious about further cuts.”

Nick Rees, senior FX market analyst at Monex Canada, says that should such a scenario come to pass, “our base case sees rate differentials continuing to grow, supporting [the possibility of the Canadian dollar plummeting] to C$1.50 by the end of 2025.” While not as severe as the record low of C$1.618 in early 2002, such a hit to the loonie’s value could stoke inflation and scupper efforts to revitalize consumer sentiment.

Ashish Dewan, senior investment strategist at Vanguard Canada, expects the divergence between US and Canadian policy rates to widen more, reaching “4.0% and 2.5%, respectively” by the end of 2025. “A 150-basis-point differential could put additional pressure on the loonie,” he adds.

What Trump Tariffs Could Mean for the Canadian Dollar

The looming threat of tariffs under the new Trump administration is seen as another significant risk to Canadian currency. “If implemented, US tariffs would likely result in further Canadian dollar weakness,” says Doyle.

While tariffs could hurt the Canadian dollar, Morgan Stanley economist Lenoy Dujon believes the impact would be short-lived. “The risk should wane gradually as we obtain more clarity around the trade policies of the upcoming US administration,” he assured investors in a note.

Still, in the short term, Dujon predicts that a combination of lower oil prices, dovish Bank of Canada policy, and tariff risks will cause the loonie to underperform its G10 peers. But he thinks that by the end of 2025, the gap between the loonie and the greenback will narrow as the latter begins to falter: “We see the USD/CAD [gap] declining into [the end of] 2025/2026 as the US dollar comes down broadly due to lower US real yields, putting downward pressure on USD/CAD [divergence].”

Elections Add to Uncertainty

Some analysts see potential positives in a likely political change of guard in Canada. Opinion surveys indicate the Conservative Party is poised to seize control of the government from the incumbent Liberals in the 2025 elections. With mounting pressure on Prime Minister Justin Trudeau to resign, Canada could hold those elections early, which could impact the loonie.

“Should Canada edge toward an early election in which a Conservative-led government emerges, the Canadian dollar could appreciate, and [the divergence with the US dollar] might peak earlier than otherwise,” contends Thierry Wizman, Global FX & Rates Strategist at Macquarie. A Conservative government (presumably under Pierre Poilievre) “would be ideologically aligned with Donald Trump, and not just in regard to their shared vision for a pro-growth political economy,” she says.

Rees thinks political developments in Canada could provide an antidote for those south of the border. “If [Trump] tariff risks do come to the fore [in 2025], a change in government [in Canada] may offer a chance to reset US-Canada relations, posing an upside risk to our bearish loonie predictions,” he says.

On the other hand, a tit-for-tat tariff spat could be detrimental to both US and Canadian economic interests. “Some of the tariff risk has already been reflected in the Canadian dollar,” says Tom Nakamura, currency strategist and co-head of fixed income at AGF Investments. “But any escalation would, of course, be a negative risk for the loonie.”

The Benefits of a Weaker Canadian Dollar

A devalued Canadian dollar has its upsides. Canadian investors can benefit from an additional boost in returns when converting gains from USD-denominated securities back into CAD. With the Canadian dollar slumping nearly 8% in 2024 against the towering greenback, Canadians invested unhedged in the S&P 500 would have racked up more than 30% for the year.

For the broader economy, a softer Canadian dollar comes with its silver linings, according to Rees: “A weaker loonie would help offset the impact of any tariffs, even as they make Canadian imports more expensive.”

Echoing that sentiment, Nakamura argues that “a weaker Canadian dollar can help Canada’s exports become more competitive.”

On the flip side, there could be damaging effects on consumer and business confidence. “If [the currency] weakness becomes too substantial, it would be an outright negative as it could mean the Bank of Canada refrains from rate cuts due to the inflationary impact,” points out Doyle. “An upturn in inflation would also hurt consumer spending power by leading to lower real wage growth.” However, if the loonie’s depreciation is driven by a strengthening US dollar fueled by a robust economy, it “should help the Canadian economy due to its close ties with the US.”

Notably, the Bank of Canada has underscored that having a flexible exchange rate helps the economy adjust to changes like tariffs. PIMCO economist Tiffany Wilding says the drop in the Canadian dollar’s value hasn’t caused a big jump in core inflation, “allowing the Bank of Canada to remain more focused on responding to the growth effects of [the proposed] tariffs.”

Looking ahead, once the trade dispute is resolved, domestic consumption picks up and Canada’s economy begins showing signs of stability, the loonie is expected to regain strength against its US counterpart.

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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