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Investing.com -- Signs show that U.S. tariffs are finally weakening the Canadian economy, increasing the likelihood of Bank of Canada interest rate cuts at an aggressive pace, says Capital Economics. In a Friday report, the research firm pointed to a softening housing market as a main indicator, further reinforced by a decline in manufacturing sales volumes.

The housing sector is leading the downturn, with April’s MLS Home Price Index falling 1.2% month-on-month, the steepest decline in several months. Annual house price inflation dropped to -3.4%, reinforcing expectations for a 5% annual decline in prices by the end of 2025.

Home sales remain soft, with overall transactions flat at 430,000 annualized units and new listings falling 1%, helping to stabilize the sales-to-new listings ratio. Capital Economics points to U.S. auto and steel tariffs, not weather, as the main driver of waning demand, especially among owner-occupiers.

Manufacturing is facing its own contraction, as March sales fell by 1.4% in nominal terms and 1.1% in real terms, the sharpest drop since mid-2024. Key subsectors like primary metals and motor vehicles suffered as tariff-driven front-loading of orders in prior months began to reverse.

Softer factory activity is now bleeding into the labor market, with manufacturing employment down 30,000 in April. Capital Economics expects this trend to continue as the full impact of U.S. trade measures works its way through domestic production and exports.

Consumer price data for April, due on May 20, may offer some relief to policymakers. Headline CPI is forecast to fall by 0.6% on the month, dragging the annual rate to 1.6%, while core trim inflation is expected to tick higher to 2.9% due to stronger goods prices.

Retail sales for March, due May 23, are expected to rebound 0.9% after February’s 0.4% decline. Lower gasoline prices and resilient demand, in spite of weakened confidence, suggest that households are still supporting modest GDP growth in Q2 2025.

Capital Economics forecasts GDP growth to slow to 0.7% annualized in both Q2 and Q3, with full-year growth expected at 1.6% for 2025 before slipping to 1.0% in 2026. “We think the Bank of Canada will need to lower interest rates more than markets are pricing in,” the firm wrote, projecting a policy rate of 2.00% by year-end, well below current market expectations.

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