Canadian economy and inflation outlook
Members then turned their attention to recent economic developments in Canada. Economic growth in the first quarter was slightly stronger than anticipated, with the composition of growth largely as expected. Exports and inventory accumulation both contributed strongly to growth as businesses sought to get ahead of the tariffs. Consumer spending and business investment had also contributed to growth, even in the face of considerable angst about US trade policy. Housing activity and government spending had declined.
While final domestic demand was flat, consumption grew by 1.2% in the first quarter. Retail trade data for March suggested that household spending had been holding up, even as consumer confidence had fallen. Members were encouraged by the strength in business investment growth in the first quarter, but they acknowledged that it was likely temporary. Spending on machinery and equipment grew by more than 20%, perhaps indicating that businesses had advanced purchases before costs increased from tariffs. Residential investment declined markedly. Members agreed that elevated uncertainty may have been weighing on home sales and lower immigration may have contributed to slower demand growth. Members noted that weakness in housing activity was concentrated in the Toronto and Vancouver areas, and they expected some support going forward from new housing policies.
Governing Council members expressed concerns about the softer labour market. Employment growth had slowed in April, with private sector employment down. The job separation rate increased, and the unemployment rate rose to 6.9%. Job markets in trade-related sectors such as manufacturing were particularly weak. Data from the April Labour Force Survey did not indicate that the deterioration of labour market conditions in these sectors had spread to other sectors of the economy. But this weakness had not been offset by strength in other sectors. Businesses also reported a slowdown in hiring intentions. Most measures indicated that wage growth continued to ease.
Overall, members agreed that the economy showed more resilience than expected. Members expected the boost in export growth to dissipate quickly as tariffs and uncertainty continued, and because the pull-forward of exports had borrowed strength from the future. With domestic demand likely subdued, they expected the second quarter to be much weaker.
Members spent considerable time discussing recent inflation data. Consumer price index (CPI) inflation declined to 1.7% in April. The elimination of the consumer carbon tax reduced the overall inflation rate by 0.6 percentage points. Excluding taxes, inflation was 2.3%, which was slightly above expectations.
Inflation in goods excluding energy continued to rise but remained close to its historical average. Food prices rose by 3.8% in April, reflecting higher costs. Members agreed that cost increases from trade disruptions may be playing a role in inflation in goods prices, but the direct impact from retaliatory tariffs was not yet evident. They acknowledged that the pass-through of higher input costs to consumer prices would be difficult to track going forward. Some members expressed concern about the increase in the breadth of CPI components growing above 3% in recent months, particularly for services. Others noted that some of the recent price growth in services could be due to one-time price increases that happened during this time. Inflation in shelter services continued to ease but still contributed significantly to overall inflation.
The Bank’s preferred measures of core inflation increased as well and were above 3%. Other measures of underlying inflation also rose, although the levels varied. Governing Council members discussed whether underlying inflationary pressures reflected the past depreciation of the Canadian dollar; the cost effects of trade disruptions as businesses adjust supply chains; the changing consumer behaviours, such as an increased preference for buying Canadian products; the timing of annual price increases for some administrative services; or a combination of these factors. Members noted that measures of underlying inflation had come in higher than they expected since the beginning of the year. They agreed they would need to watch developments in inflation across CPI components carefully to gauge how inflationary pressures are evolving.
Near-term inflation expectations had risen in the first quarter, and results from recent surveys continued to suggest consumers expect prices to rise because of tariffs. Survey evidence and insights from regional outreach showed that businesses also anticipated an increase in costs from tariffs and from efforts to reorganize supply chains and pursue new markets for their goods. Many reported that they would be passing on these extra costs to their customers in the form of higher prices.
While economic activity was showing some resilience in the face of trade uncertainty, members recognized that a period of weaker economic growth lay ahead. At the same time, they noted that inflation was somewhat stronger than expected. The increase in core inflation may suggest underlying inflation was firmer than they had previously thought. They agreed they would need to continue to carefully assess the timing and strength of both the downward pressure on inflation from a weaker economy and the upward pressure on inflation from higher costs.
