Risks

The evolution of Canada’s trade relationship with the United States and the war in the Middle East remain the two most important risks to the outlook for inflation.

The base‑case projection assumes that the Canada‑United States‑Mexico Agreement remains in place with annual reviews. The economy is adjusting to US tariffs, and the impact of trade‑related uncertainty is assumed to gradually fade. However, the United States could announce further trade measures. Uncertainty could also persist for longer than assumed, weakening business investment and household spending.

The projection also assumes that shipping through the Strait of Hormuz gradually returns to normal. Nevertheless, uncertainty remains high. In recent days the strait has closed once again with an escalation of hostilities. If these hostilities lead to another sustained closure of the strait, energy prices will rise and the supply of other commodities will be disrupted, pushing up inflation globally.

The outlook for inflation is also subject to other risks.

Upside risks to inflation

Cost pressures could be stronger than expected

The war in the Middle East has raised input costs for businesses. This is expected to put upward pressure on prices in Canada, especially for food and other goods. The Canadian dollar has also depreciated recently, adding to the costs of imported goods.

In the base case, businesses are assumed to absorb some of the increase in costs. However, if the increase in costs is greater than expected or if businesses end up passing on more of these costs to their customers, inflation will be higher than anticipated.

Trend productivity growth could be weaker than assumed

The outlook for inflation depends in part on the degree of excess supply in the economy. Estimates of excess supply are influenced by potential output, which depends partly on trend labour productivity. In the base case, trend labour productivity is estimated to have picked up in 2025 and to continue growing strongly over the projection horizon.

However, if it turns out that there was less trend labour productivity growth in 2025 than estimated, the output gap would be smaller at the beginning of the projection. Trend labour productivity growth beyond 2025 could also be lower than assumed. This could occur, for example, if business investment turns out to be weaker than projected. As a result, there would be more upward pressure on inflation.

Downside risks to inflation

Global financial conditions could tighten, spilling into Canada

The outlook for the United States assumes a strong pace of investment in artificial intelligence (AI) and related gains in equity markets. However, technology stocks have been volatile since the start of the year. A sharp reassessment of the prospects for AI could trigger a correction in equity markets, reducing both consumer confidence and household wealth in the United States and abroad.

At the same time, yields for long‑term government bonds could rise if investors demand greater compensation because of the rapid rise in sovereign debt worldwide.

Either development would tighten financial conditions and weaken demand for Canadian goods and services, creating excess supply and putting downward pressure on inflation in Canada.

The pickup in GDP growth may not be sustained

In the base case, growth in gross domestic product (GDP) picks up and remains solid over the projection horizon. However, several factors could jeopardize the sustainability of the recovery:

• The rebound in exports could be weaker than expected due to ongoing competitiveness issues.
• Continued trade uncertainty could lead to further layoffs in affected sectors. At the same time, skills and geographic mismatches could slow workers’ transitions to new jobs. Weaker employment would weigh on household spending.
• The overhang of unsold condominiums in Vancouver and Toronto, along with affordability issues, could mean that the recovery in housing activity is slower than expected.

Weaker growth would reduce domestic pressure on inflation.