Monetary Policy Report—July 2025
Considerable uncertainty surrounds the outlook for inflation. It is extremely difficult to predict how US trade policy will play out and how businesses, households and governments will react to a given level of tariffs. The outlook also faces risks that are not directly related to tariffs.
There are three main types of risks to the outlook for inflation. The first is the level of tariffs. To address this risk, this Report presents a current tariff scenario and two alternative scenarios—a de-escalation scenario and an escalation scenario. When taken together, these scenarios encompass a range of potential outcomes (see the Outlook and Global economy sections and In focus: The path of US tariffs remains uncertain).
The second type is the effect that tariffs will have on the economy. Regardless of how US trade policy evolves, risks remain with respect to how businesses, households and governments will react and adapt. Tariffs, counter-tariffs and the reconfiguration of trade could lead to more persistent cost pressures than captured in the scenarios. This is of particular concern given the recent uptick in underlying inflation.
The third type encompasses risks beyond those related to the trade conflict. This section addresses the second and third types of risks.
Main upside risks to inflation
Trade conflict could put greater upward pressure on inflation
Tariffs could put greater upward pressure on inflation than in the current tariff scenario:
- Businesses may pass on a larger share of the cost of tariffs to consumers. This pass-through may also happen at a faster pace.
- Global supply chains could be more severely affected, and the costs of reconfiguring trade could be higher than assessed, raising production costs and import prices.
- Businesses not directly impacted by tariffs may take advantage of the reduced competition and raise their prices.
- Inflation expectations could drift higher, especially given the recent experience of high inflation. Consumers and businesses affected by tariff-related price increases may begin to expect that prices will rise persistently at an elevated pace. This expectation could feed through to wage demands and costs and could influence how businesses set their prices.
These risks would likely be amplified in the escalation scenario.
Geopolitical tensions could increase costs
Ongoing geopolitical tensions could lead to unexpected upward pressure on costs. For example, oil prices could rise sharply if tensions in the Middle East increased or Russia’s war on Ukraine escalated again. This would drive up fuel prices and cause inflation to rise. If these conflicts were to escalate, global supply chains could also be disrupted.
Main downside risks to inflation
Tariffs could weaken the economy more than expected
The demand for Canadian exports may be weaker than in the current tariff scenario. This could arise because:
- global economic activity is weaker
- US tariffs on Canadian goods have a bigger impact than expected
In addition, the weakness in the export sector could spread to the rest of the Canadian economy by more than expected.
With unemployment already at elevated levels and households uncertain about their economic future, spending on housing and other major purchases could be meaningfully softer. This impact could be amplified by the recent weakness in some regional housing markets. Greater excess supply in the Canadian economy would create more downward pressure on inflation.
Global financial conditions could be tighter
Long-term government bond yields could increase in response to the rapid expansion of government debt issuance around the world. This could, in turn, lead to higher borrowing costs for Canadian households and businesses. The result would be weaker domestic demand and greater downward pressure on Canadian inflation because of excess supply.