In 2025, the economy will have to navigate two simultaneous realities.

Taming inflation was a major victory in 2024. We will start to see the benefits this year as additional interest rate cuts from the Bank of Canada trickle through the economy. The growth outlook may be unchanged on the surface from 2024, but drivers of that growth will shift, and the economy will expand on a per capita basis for the first time in three years.

Yet, the path forward is uncharacteristically uncertain. There is policy uncertainty from the incoming U.S. administration, geopolitical schisms, and the looming Canadian federal election. There are new headwinds from lower immigration targets, and old ones from unaffordability and low productivity growth. Multiple risks mean a wide range of economic outcomes will need to be considered amid a challenging backdrop for Canada.

However, there are ways for businesses and governments to navigate these risks while carefully seizing the opportunities that will cement tomorrow’s growth.

High inflation is gone but its risks will not be forgotten

Annual inflation is expected to remain below 2% for 2025. That’s good news for households, who will see incomes rise faster than inflation this year. Wages have increased more than prices from pre-pandemic levels—average hourly earnings are up 23% from 2019 compared to a 19% increase in average prices. However, income gains have been uneven (more on that below), and a different mix of inflation— such as prices for essentials like food and shelter outpacing average price growth—will continue to be a challenge, particularly for households at the lower end of the income distribution.

Monetary policy is currently too restrictive for inflation to be sustainably at target, which will lead the Bank of Canada to further ease policy with more interest rate cuts in 2025. The downside risk to inflation is that the central bank doesn’t cut rates fast enough to support a dwindling economy.

The upside risk to inflation is that nominal wages could persist at higher levels for longer. A significant acceleration in housing market activities, although not in our base case, could also add to shelter inflation.

As we’ve discussed before, a weaker Canadian dollar is unlikely to import significant inflation, but the bigger external risk is a tit-for-tat tariff standoff affecting a large range of consumer goods. Overall, we’re more concerned with the downside risks than the upside risks.

Implication: Businesses will find it harder to pass on higher costs to customers, limiting the upside to profit margins, and requiring continued focus on efficiency and cost management.

Lower interest rates drive the improved outlook but mortgage rates may not budge much

The central bank has shifted focus from taming inflation by cooling the economy to supporting a gradual reacceleration of activity. We expect the overnight rate to reach 2% by mid-year and provide a major boost to 2025, especially in the second half of the year, driving financing costs lower for investment and cushioning against the mortgage rate renewal shock.

However, lower policy rates in 2025 may not be enough to further materially lower three to five-year Canadian bond rates, off of which mortgages are priced. These rates are already expected to remain relatively steady in 2025. They have priced in monetary easing in Canada, and are being lifted by higher rates in the U.S.

Implication: The average household debt burden will stabilize in 2025 and improve for some, but many households will still face a payment shock.

Immigration policy reversal will limit growth

Reductions in Canada’s immigration and temporary resident targets will take hold in 2025 and significantly deflate the population boom, weighing on topline growth. If the government can cut in-migration as much as intended, it will shave 2.7 per cent off real gross domestic product over the next three years from previous projections. Longer-term, slower labour force growth also means less government revenue to support growing public expenditures from an ageing population.

Our forecast assumes that fewer net migrants deduct equally from both the demand and supply sides of the economy. The unemployment rate is expected to still tick up in 2025 so the economy in aggregate also does not need as many workers. But, businesses will start planning for growing labour demand around the corner when some sectors could feel the squeeze from lower immigration targets.

Implication: Businesses and governments can start to plan for growing future labour demand by upgrading the skills of the existing workforce, drawing underutilized populations into the domestic labour pool, or investing in automation.

A tale of two consumer experiences

Most economic developments will be moving in the Canadian consumer’s favour in 2025, particularly in the latter part of the year. Inflation and nominal interest rates will fall, the unemployment rate will peak by mid-year, and the average debt burden will stabilize following the wave of mortgage renewals. Per capita GDP, which has fallen for much of the past two years, will rise. Canadian households will continue to possess record wealth. So, why will consumption growth slow to just 1.6% in 2025?

For one, slower population growth will slow consumer demand on an aggregate basis. Many of these developments also don’t kick in until later in the year.

We also continue to flag a theme we feel is underestimated—the bifurcated consumer experience. Some households will see improvements in affordability in 2025, while others will continue to face hardship, keeping growth tepid in the future. Consumer prices are still higher than before the pandemic, while labour market weakness has disproportionately impacted younger workers and newcomers. Recent wage growth has also been uneven.

Implication: Consumer segments will continue to be price sensitive.

Business investment growth to turn positive but threat of tariffs loom

Like consumers, businesses will benefit from lower interest rates and improving consumer demand throughout 2025, as well as ample liquid assets from strong profit growth in recent years. Nonetheless, investment intentions remain below the historical average.

Making up lost ground will be difficult with uncertainty and trade turmoil being the new normal. Residential investment will drive overall business investment higher in 2025, but non-residential investment will fall, as businesses wait to see how policy uncertainties resolve.

There are further downside risks. Potential significant U.S. tariffs on Canada would turn the external sector into a drag on growth. This would impact investment as well given capital expenditures in trade-exposed sectors are generally higher than in others. Even less punitive actions could have detrimental effects over time. The incoming U.S. administration’s tariff threats, America First posture, and deregulation focus could be strong forces pulling investment south of the border.

Implication: 2025 will be about building buffers so businesses can nimbly manage through trade and other uncertainty. For example, some businesses will add to inventories or diversify trading partners. Dedicating risk capital to develop footholds in long-term strategic technologies, like AI or green supply chains, could support long-term competitiveness.

Canada-U.S. economic divergence pressures interest rates and loonie

The Canadian and U.S. economies are tracking very differently with a challenging growth backdrop in Canada compared to resilience in the U.S. We view this as both a cyclical issue, but also a more engrained long-term difference. Higher productivity growth and very high government deficit spending will continue to support U.S. growth in 2025, and lower easing in inflation. The U.S. Federal Reserve is set to pursue a slower pace of rate cuts, quite likely to a higher terminal rate, which has led the Canadian dollar to dip below US$0.70 for the first time in 20 years.

The Canadian dollar is a shock absorber, buffering the impact of international trade and investment flows on the Canadian economy. Fluctuations in the degree of Canada and the U.S.’s monetary policy divergence, potential on-and-off tariffs or changing investment flows could result in volatility in the year ahead. Still, the Canadian dollar’s weakness is mostly a reflection of U.S. exceptionalism: the loonie will gain at least a little by the end of 2025 versus most other major currencies.

Implication: Businesses ramping up investment could look to firm contracts for imported machinery and equipment, while those with high currency exposure could consider hedging strategies. Canadian travellers will increasingly be looking at domestic or non-U.S. travel options.

Structural issues take centre stage in fiscal policy

Policymakers need to focus on tackling the economy’s long-run challenges, which may be “structural,” but also urgent. The threat of investment increasingly being diverted stateside and ongoing affordability headwinds to growth mean Canada will need to tackle business underinvestment, lagging productivity growth, and housing undersupply. Government structural policies will take centre stage. Canadian government finances are in decent shape, but preserving fiscal health is paramount.

However, fiscal management could become more difficult. A volatile external environment, such as major U.S. tariffs, could weigh down economic growth and government revenues at a time when the economy needs additional support, and monetary policy could be focusing on addressing inflationary pressures. Government spending priorities could also be increasingly dictated from afar from defence spending to defensive business investment measures.

Implication: Governments can build contingencies into their fiscal planning approaches. Being focused on growth-enhancing spending will ensure finances remain sustainable.

Cynthia Leach is the Assistant Chief Economist, Thought Leadership at RBC, where she works on the team’s structural economic and policy analysis. She joined in 2020.


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