By Douglas Porter, CFA, Chief Economist and Managing Director, BMO Financial Group

In the opening months of 2025, economic forecasters are dealing with a serious bout of cognitive dissonance—we keep projecting steady growth and moderate inflation, even when faced with cascading risks to the outlook, which could easily lead to the opposite of “steady or moderate”. In fairness, those risks cut both ways: geopolitical and trade risks point to the downside, but still-healthy financial markets point to upside risk for growth this year. And note that this is fairly similar to the position of a year ago—fraught geopolitics, solid markets—and 2024 turned out to be characterized as steady growth in most major economies with moderate inflation.

A brief look back at last year reveals that the consensus was again too cautious on the growth outlook, especially for the tireless U.S. economy, but were pretty much on target for the cooldown in consumer price trends. So, after inflation’s two-year reign of terror, central banks were able to begin the process of bringing down interest rates, albeit at wildly different paces. While the Fed’s step down wasn’t exactly smooth, the 100 bps of total rate cuts last year was precisely what we were anticipating at the start of 2024. The big surprise in the U.S. was another year of nearly 3% GDP growth, but that was driven by solid productivity gains, so inflation ebbed and unemployment nudged up, both mostly as expected.

The friendly combination of still-solid growth, calming inflation, and easing central banks helped power global equity markets to record levels in early 2025. Given that stocks tend to lead the economy, and that central banks have aggressively cut rates with inflation back close to target, we would normally be looking for sturdy economic growth in the year ahead. But the darkening cloud of trade protectionism counsels caution, especially for Canada, Mexico and China.

What does 2025 hold for the global economy? After the Year of the Election in 2024, a few more major economies face potential power shifts this year, in Canada but also France, Germany and South Korea. Despite choppy political waters and meaningful trade uncertainty, the growth outlook remains constructive amid robust financial markets, central bank rate cuts, cooler energy and food prices, and normalized supply chains. Even with the ongoing tariff threat, we are looking for the global economy to grind out another year of roughly 3% real GDP growth, just mildly below the long-term average of around 3.5%—but the U.S. tariffs mean the risks are tilted to the downside.

Among the major economies, the U.S. remains the standout as we look for growth to step back only slightly in 2025. Yet, we expect the jobless rate to drift higher as robust productivity gains continue. A less-tight labour market and slightly cooler inflation trends are expected to allow the Fed to keep gradually trimming rates, albeit delayed by the uncertain impact of tariffs. We look for another 50 bps in total cuts in 2025, bringing the overnight rate down to 3.75%-to-4.00% by year-end, which is still judged to be slightly restrictive. We would again highlight the magic word: productivity. Plus, the inflationary impact of any tax relief flowing from Washington would be a 2026 story, while the growth-dampening impact of trade frictions and high-profile government spending cuts will bite sooner.

There is a great deal of debate among analysts over the degree of inflationary risk for the U.S. economy from tariffs. But there is little debate over the direction of risk, with at least some of the tariff impact likely to seep into consumer prices. And that increased risk, at a time when U.S. core inflation has proved sticky at just above 3% and growth has stayed solid, is expected to keep the Fed on the sidelines for some time yet.

In contrast to global resiliency, Europe is struggling with sub-1% GDP growth. Germany and its new government are particularly challenged, posting a mild contraction for the second year running as its major export industries (autos and capital equipment) are battling Chinese competition, and now potential U.S. tariffs. France is burdened with tough fiscal math and some political uncertainty. Yet, smaller Euro Area economies are faring much better, and ECB rate cuts will support 2025. It’s a similar story in Britain, where GDP growth has been stuck below 1%, inflation is near 3%, and the BoE is easing—albeit more cautiously than the ECB. Both regions have so far avoided the worst of the tariff spotlight from the U.S. President. The UK is unlikely to be specifically targeted given it runs a trade deficit with the U.S., though the possibility of across-the-board tariffs poses a risk to the outlook.

China’s economy managed to grind out slightly better growth than we anticipated last year, although the 5% advance relied heavily on exports. The property crisis rolls on, weighing on domestic spending, but China has pledged forceful monetary and fiscal stimulus. The economy is going to need it, as U.S. President Trump has already imposed additional tariffs on China’s goods—and few believe he is bluffing on further actions. We expect the chillier trade backdrop to shave China’s GDP growth to 4.3% in 2025.

Pulling these strands together for Canada’s outlook, the global growth backdrop and broadly stable commodity prices are mostly neutral. Unfortunately, the trade backdrop is anything but; as the Bank of Canada noted, the U.S. 25% tariff “is a major new uncertainty”. Indeed, broad-based tariffs of that magnitude are overwhelming almost any other issue affecting the Canadian economy. Even if tariffs are moderated—or, best case scenario, are unwound—the deep uncertainty casts a pall on the investment outlook.

The tariffs, and the very serious retaliation, have emerged just as the domestic side of the Canadian economy looked to be improving. Home and auto sales are now clearly responding to rate relief, household debt ratios are falling fast, and some modest fiscal stimulus will further lift domestic spending in 2025. Alas, growth will do well to reach 0.5% in a tariff world (even assuming very stimulative monetary and fiscal responses). Our base case now calls for 100 bps of Bank of Canada interest rate cuts, on top of the past year’s world-leading 200 bps, taking the overnight rate down to 2.0% by mid-year.

In direct contrast to the Fed, the BoC is expected to keep driving rates lower, perhaps forcefully so. True, it’s not a straightforward call on how the BoC responds to a trade war, especially since underlying inflation has moved higher again in recent months, and job growth has somehow sprung back to life. But we believe that the concerns over the negative growth impact from a trade war will dominate any concerns over the inflation impact for Canada. So, it is very likely that tariffs, if kept in place over a meaningful period, would weigh on growth enough to fast-track BoC easing and perhaps drive rates lower than we currently expect.

The Canadian dollar has been under sustained pressure from the dark trade outlook and a generally strong U.S. dollar, dropping to a 20-year low below the 70-cent level (above $1.44/US$). A surprisingly aggressive set of rate cuts from the BoC gave it an initial push, but the U.S. tariff threat and a broad greenback rally were the mightier blows—it will take a trade détente to turn the loonie around. A continued full trade war will send it much lower.