It’s a tale of two economies for the Bank of Canada as it tries to predict outcomes of a global tariff war: a temporary stall in Canadian activity or an outright downturn that lasts a year.
The uncertainty around U.S. President Donald Trump’s trade policy prompted the central bank to publish two sets of forecasts, instead of a single projection, to capture different possibilities. It released the scenarios Wednesday as it paused its easing campaign for the first time since it began cutting rates last June.
“What happens to the Canadian economy and inflation depends critically on U.S. trade policy, which remains highly unpredictable,” Governor Tiff Macklem said in prepared remarks. “Given this uncertainty, point forecasts for economic growth and inflation are of little use as a guide to anything.”
In the first scenario, policymakers assume most of Trump’s tariffs get negotiated away. His 25 per cent levies on steel and aluminum and Canada’s associated retaliation remain, as does a 10 per cent U.S. tariff on Chinese goods and Chinese retaliation equivalent to a one per cent increase in its weighted average tariff rate on U.S. products. China’s tariffs on some Canadian agricultural products, pork and seafood also stay in place.
But even in this scenario where most tariffs are scrapped, the process is unpredictable and businesses and households remain cautious. The uncertainty around trade policy weighs on activity.
As a result, gross domestic product growth stalls in the second quarter, with exports falling sharply and business investment contracting. Consumption is subdued in the near term as households build up precautionary savings due to concerns about future employment prospects and wealth. The economy then begins expanding only moderately, averaging around 1.6 per cent through the end of 2027.
Inflation drops below the two per cent target for the rest of this year and into next year because of a weak economy and the end of Canada’s consumer carbon tax. However, goods inflation, excluding food and energy, is above the historical average in the second half of this year due to Canada’s retaliatory levies, delayed effects of the weakened loonie from late last year and businesses attempting to avoid future tariffs shifting to higher-cost suppliers.
‘Significant recession’
In the second scenario, the central bank assumes some major U.S. tariffs remain, including 25 per cent levies on motor vehicles and parts, along with Canada’s associated retaliation. It sees Trump adding a 12 per cent tariff on many Mexican and Canadian goods — the White House outlined this figure on April 2 but exempted the countries for the time being. The scenario sees Canada retaliating with 12 per cent tariffs on $115 billion (US$82.8 billion) of U.S. goods. It also assumes the U.S. puts a 25 per cent tariff on goods imported from all other countries, including China.
The scenario pitches the globe into a long-lasting trade war, and the economic consequences are severe. Canada’s GDP contracts in the second quarter, and the economy spends a year in what the bank called a “significant recession,” which permanently lowers the standard of living in the country.
The four straight quarterly contractions average about 1.2 per cent. Exports fall sharply until mid-2026, and tariffs permanently reduce U.S. demand for Canadian products. Canadian exporters reduce production and lay off workers, leading to higher unemployment and a slowdown in household spending. Business investment declines due to weak economic activity. A lower Canadian dollar raises the cost of imported equipment and machinery. Growth gradually returns in 2026 but remains soft through 2027.
Inflation in Canada averages around two per cent until early 2026, before rising above three per cent because of upward pressures on prices from tariffs. It then returns to the two per cent target in 2027 as weak demand limits ongoing inflationary pressures. Globally, tariffs drive up inflation, especially in the U.S., starting in the second quarter of this year.
Consumers and businesses affected by tariff-related price increases may begin to expect that prices will continue to rise at an elevated pace, leading to an upward drift in longer-term inflation expectations. These expectations can become self-fulfilling if they feed through to wage demands and if businesses change how they set prices — a significant risk, given the recent experience of high inflation, the bank warns.
“As we considered monetary policy, we used these two scenarios to reflect uncertainty about U.S. trade policy,” Macklem said. “What happens with inflation will depend on what happens with tariffs. Monetary policy will ensure inflation remains well controlled and support economic growth as Canada confronts this unwanted trade war.”
Randy Thanthong-Knight, Bloomberg News
©2025 Bloomberg L.P.
