Canada’s central bank will probably raise interest rates next year as risks tilt in the direction of higher inflation, according to a report by Scotiabank economists.

Jean-François Perrault, René Lalonde, Patrick Perrier, and Farah Omran said in their latest outlook that several forces could keep inflation from falling as expected, noting that “weak productivity, strong wage growth, rising input costs and the potential for rising U.S. import prices... all point to upside risks to inflation despite growing excess supply.”

Recent data point to uneven performance across sectors, and “evidence of economic damage is clear in many communities with unemployment rates in trade-impacted areas substantially higher than elsewhere in the country,” however there are “signs of vigour in the labour market” with over 120,000 jobs added in recent months and strong auto sales, the economists said.

Because of these risks, they believe the Bank of Canada is unlikely to cut rates any further. “We expect Governor Macklem and his colleagues will raise the policy rate by half a percentage point in the second half of 2026, reversing the most recent cuts.”

Canada’s economy will likely improve modestly in 2026 despite ongoing uncertainty stemming from U.S. trade and tariff policies, highlighting stronger domestic policy support and investment initiatives as key stabilizing factors, the economists said.

They forecast “Canadian economic growth improves in 2026 relative to 2025,” though “this is admittedly not a very high bar, as growth would go from 1.2% this year to 1.4% next year owing to the damaging impacts of tariffs and related uncertainty.”

The economists said the 2025 federal budget largely aligned with their expectations, but they revised their forecasts to reflect a slower pace of immigration. “Immigration policy seems to target a lower rate of population growth going forward than we had assumed,” they wrote, adding that “we now assume population growth of 0.5% in 2026 and 2027.”

Perrault and his colleagues expect governments to continue pursuing major infrastructure and industrial projects. “We expect non-residential investment to rise starting in early 2026 but weak momentum towards end-2025 and early 2026 mean that investment will likely fall in 2026 despite policy support. Investment should strengthen more robustly in 2027... but there are clear risks of under-execution.”

Waiting for evidence

Finance Minister François-Philippe Champagne and Prime Minister Mark Carney have projected $1 trillion in new investment over five years. Scotiabank economists wrote that “investment growth would be significantly stronger were even a fraction of this to occur in 2026 or 2027,” but said they will wait for “tangible evidence” before including it in forecasts.

They also noted that Buy Canada policies will probably keep imports from rising as much as they normally would, so imports won’t hold back economic growth as much.

On the upcoming CUSMA review, the economists wrote that “it is entirely unclear what, if any, demands the U.S. may have,” but took comfort that most goods remain tariff-free, calling it “a recognition of the importance of the trade deal to U.S. economic interests.”

Still, they warned, “that hope will likely be strained by a to-be-expected ramping up of caustic language by Trump Administration officials with respect to Canada as the review unfolds.”