Slight Improvements in the Outlook, for the Time Being: Scotiabank’s Forecast Tables

• Incoming data and fiscal policy announcements in the U.S. and Canada suggest growth will be modestly stronger than earlier anticipated.

• Both economies are still expected to grow below potential growth rates this year and next owing to U.S. trade policies and the associated uncertainty, but inflation pressures will limit central bank ability to respond to slower growth.

• We continue to hold to our long-standing view that both the Bank of Canada and Federal Reserve will remain on hold for the remainder of the year.

• Our forecast does not reflect recent trade pronouncements in the U.S. We will wait until policies actually take effect before reflecting those in our forecasts. There is simply too much uncertainty about the way forward on trade to build those into our forecasts at the moment.

There is lots of noise on the trade side that could have meaningful impacts on the global outlook. Time will tell how things settle, but we consider it premature to incorporate recent threats and announcements into our forecasts. As a case in point: some days President Trump says the letters he has sent are the final deals, other days he says they are open to negotiation. We are unlikely to have clarity on the tariff front until early August, and even then, things risk looking opaque. As is our long-standing practice, we will incorporate trade developments as they come into force. At present however, President Trump’s more recent trade threats seem like they would result in stronger downward revisions to growth and higher revisions to inflation in the U.S. relative to its trading partners.

For the time being, our forecast update reflects the impact of incoming data and fiscal policy announcements in Canada and the U.S. in particular. The net impact of these developments is an upward revision to the outlooks in both countries.

Growth in Canada appears to be on a better track than we had assumed in our last forecast. We had anticipated a one percent decline in real GDP in Q2, for instance, and our tracking now suggests something slightly above zero. We are seeing quite unexpected signs of a strengthening in the labour market, with 83k jobs created in June, and hours worked rising by 1.3% at annualized rates in the second quarter. Moreover, sales of existing homes have been rising for the last three months, suggesting a recovery in the housing market may be underway after significant weakness post U.S. election. Moreover, informal conversations with clients suggest a more optimistic view of the outlook relative to the last few months. This is not to say the economy is strong, it remains weak across a broad range of indicators, but on balance the economy is less weak than we had earlier assumed. Ongoing trade negotiations could of course affect the outlook, but it bears emphasizing that the most recent tariff threat of 35% tariffs on non-CUSMA eligible exports to the U.S. (from the current 25% rate) would cause reasonably minor additional aggregate economic impacts if enacted.

Against this context, underlying measures of inflation in Canada remain in the three percent range and risks continue to point to stronger, rather than weaker, inflation in coming months. This combination of stronger, but not strong, growth and resilient inflation confirms our long-standing view that the Bank of Canada would remain on hold for the remainder of the year. Indeed, market pricing is coming around to this view even though markets are still pricing in a chance of a cut by year-end.

The U.S. outlook continues to be subject to significant uncertainties. As noted above, we are not reflecting the impact of recent trade letters, but we do incorporate the impact of the One Big Beautiful Bill. This results in a more stimulative fiscal policy at the margin as our forecasts had never incorporated the phasing-out of the tax cuts implemented in the first Trump mandate. The fiscal law presents a number of challenges for the outlook: it complicates inflation management, it adds significantly to fiscal sustainability concerns, and it may well raise the sovereign risk premium for the U.S. This, in addition to the increasingly shrill calls for the removal of Federal Reserve Chair Powell point to heightened financial market uncertainty going forward, with virtually all signs pointing to higher borrowing costs. It may be the case that an early Powell dismissal could lead to lower policy rates this year if his replacement follows President Trump’s desire for the Federal Funds Rate to be cut by 300 basis points, but this would likely curtail demand for U.S. assets significantly, leading to higher longer-term yield spreads, a lower dollar, and potentially lower equity valuations. Time will tell how this evolves.

For the moment, the U.S. economy is weakening less rapidly and equity markets have been stronger than expected, as is the case in Canada. We have revised up our forecasts for growth modestly this year and next, with growth of around 1.5 per cent this year and next now expected. The outlook continues to reflect the negative impacts of tariffs and policy uncertainty, which, as noted above, could lead to downward revisions to growth once there is more clarity about the policy environment. Though this below potential growth will create excess supply in time that should put downward pressure on inflation, we continue to believe that upside risks to U.S. inflation dominate because of the tariff shock. We are starting to see signs of this in inflation data, and these effects will be even more apparent in coming months. While monetary policy should in theory look through one-off impacts on things like tariffs on inflation, the chaotic rollout of the U.S. trade agenda is creating serial tariff shocks that will be hard to distinguish from one-off impacts. Firms and households already have inflation expectations that are inconsistent with the Fed’s mandate. That risks rising further if inflation rises. As a result, we remain comfortable with our long-held view that the Federal Reserve will remain on hold for the remainder of the year but cut interest rates next year as the build-up in excess supply starts to put downward pressure on inflation. We would of course revise these views if Chair Powell were to vacate his position.