Current conditions

The Canadian economy is expected to have grown modestly in early 2026. After being close to 2% for more than a year, inflation increased in March as the war in the Middle East pushed up oil prices. Inflation is expected to rise further in April.

The economy continues to adjust to structural changes. US tariffs and related uncertainty have weighed on affected sectors, curbing investment and hiring. Some businesses have reported diversifying their export markets and reconfiguring their supply chains. At the same time, artificial intelligence (AI) is leading to greater automation and digitalization.

Economic activity is estimated to have grown moderately in the first quarter of 2026. Solid growth in consumption and government spending along with a boost from inventory investment were partially offset by a drop in both housing activity and exports.

Consumer price index (CPI) inflation picked up in March because of higher gasoline prices, while measures of core inflation remained near 2%.

The war in the Middle East is affecting the Canadian economy primarily through higher commodity prices. Since the war began, oil prices have soared. While Canada benefits as a net energy exporter, the boost to growth is likely to be limited. Higher gasoline and food prices weigh on household purchasing power, and foreign demand for Canadian non-energy exports will likely weaken.

The war has also added to overall uncertainty. If the global price of oil remains high for longer than assumed in the base case, broader cost pressures could emerge. This raises the risk that elevated inflation will persist.

Economic activity

Gross domestic product grew 1.7% in 2025. Growth was uneven across demand components. Consumption and government spending were solid. In contrast, exports and business investment declined amid US tariffs and trade policy uncertainty.

Economic activity contracted in the final quarter of 2025, mainly due to a sharp drawdown of inventories (Chart 1). Growth in final domestic demand was solid at 2.4%, and exports were lifted by gold shipments.

Final domestic demand supports growth in the first quarter of 2026

Although the economy started the first quarter of 2026 on a weak footing, recent indicators have been more favourable. The economy is estimated to have grown by about 1.5% in the first quarter, broadly in line with expectations at the time of the January Report. Growth reflects strength in final domestic demand and a boost from inventory investment. Exports and housing will likely subtract from growth.

For the first quarter of 2026, consumption growth is estimated to have remained solid, given past interest rate cuts and previous gains in equity prices. However, surging gasoline prices squeezed household budgets late in the quarter, likely weighing on discretionary spending—especially for lower‑income households. Growth in government spending continues to be strong, with support from provincial infrastructure investment and federal defence spending. Business investment appears to have risen modestly, although investment intentions remain weak in sectors affected by tariffs.

Residential investment is expected to have contracted in the first quarter. Stretched affordability and the recent slowdown in population growth are constraining demand and weighing on housing activity. Unseasonably cold weather also slowed resale activity.

Exports are estimated to have declined because of both the ongoing effects of US tariffs and a temporary drop in motor vehicle shipments linked to retooling (Chart 2). Increased shipments of energy products as well as exports into new markets provide some offset.

Capacity pressures

The output gap for the first quarter of 2026 is estimated to be in the range of -1.5% to -0.5%, unchanged from the January Report. A range of indicators suggest some slack in the labour market (Chart 3).

The participation rate has continued to decrease over the past 12 months mainly due to population aging. Labour market weakness has also played a role, although to a lesser extent, with weak hiring and fewer vacancies likely reducing incentives to search for a job.

Most measures of wage growth are between 3% and 3½%. Bank of Canada survey results also point to wage growth slightly above 3%.

Inflation

Inflation slowed to 1.8% in February before climbing to 2.4% in March as gasoline prices soared (Chart 5). Inflation is expected to rise further in April, reaching about 3%. Measures of core inflation have been easing, with CPI-trim and CPI‑median at 2.2% and 2.3%, respectively. Moreover, the three-month annualized rates of CPI‑trim and CPI‑median are at or below 2%. The share of CPI components with inflation above 3% has declined but remains higher than its historical average, largely due to high inflation across many food categories (Chart 6).

Since November, inflation has slowed or remained relatively stable in the major CPI categories except energy (Chart 7). With the exception of inflation in rent and some food components, which remains elevated, inflation in the other components is close to historical norms.

The war is pushing up oil prices and transportation costs. Higher prices for gasoline, diesel and jet fuel have led to the introduction of fuel surcharges for some goods and services. The temporary suspension of the federal fuel excise tax will cushion part of the increase. Fertilizer prices have also risen, and shortages may put upward pressure on food prices over time. Shipping disruptions could further add to cost pressures.

Results of Bank surveys show that businesses’ short-term inflation expectations rose in March and April (Chart 8). Longer-term inflation expectations remain anchored.

In the base‑case projection, Brent oil prices are assumed to decline gradually from an average of US$90 in the second quarter of 2026 to US$75 by mid-2027 (see the Tariff and other assumptions section). This assumes some normalization of oil supply as crude exports through the Strait of Hormuz gradually resume. This profile is broadly in line with that of the futures curve for Brent oil. However, the outlook for oil prices is subject to a high degree of uncertainty and could change quickly with events (see In focus: The war in the Middle East—Transmission channels and risks to inflation).

Natural gas prices have diverged globally

The global supply of liquefied natural gas (LNG) has decreased following the shutdown of the LNG terminal in Qatar and the repeated closures of the Strait of Hormuz. As a result, natural gas prices in Europe and Asia have risen sharply (Chart 11).

In contrast, prices for natural gas in North America have declined due to abundant domestic production and limited LNG export capacity that reduce exposure to global price pressures.

Non‑energy commodity prices are roughly unchanged

The Bank’s non‑energy commodity price index is broadly unchanged relative to the January Report. Prices for base metals increased by about 15% in 2025—due to supply disruptions in several mines and strong global investment in infrastructures, including AI and green technology—and have shown little change since the January Report. A notable exception, however, is the price of aluminum, which rose by about 10% because of supply disruptions in the Middle East. At the same time, prices for precious metals, including gold, have partially reversed their previous sharp gains (Chart 12).

The impact of the war in the Middle East on agricultural commodity prices has been limited so far. The Gulf Region accounts for roughly 30% of global exports of urea, a widely used fertilizer. Prices for fertilizer have increased significantly since the start of the war due to shipping disruptions and higher prices for natural gas—a critical input to production. If sustained, these developments could place renewed upward pressure on agricultural prices later in the year.

Financial conditions

Markets are pricing in higher policy rates at major central banks, reflecting heightened inflation risks from the war in the Middle East. This has supported an increase in global bond yields (Chart 13, panel a). Global equity markets declined nearly 10% at the start of the war and most have fully recovered following ceasefire announcements (Chart 13, panel b). Credit spreads have widened slightly since the January Report.

The US dollar has appreciated against most major currencies since the January Report, reversing earlier weakening at the beginning of 2026. The Canadian dollar has traded generally near 73 cents US.