The marked appreciation of the Canadian dollar has continued to restrain activity. The economy may now be operating slightly below potential, although most economic fundamentals have remained sound. Activity is expected to accelerate somewhat in the second half of 2005, once the effects of currency movements have been worked through, before slowing next year. The recent surge in oil prices is boosting headline inflation temporarily this year.

Uncertainties about the impact of the currency appreciation on activity have warranted a pause in monetary policy tightening, but further increases in interest rates will be needed from the second half of 2005 onwards. Regardless of how the current political uncertainties are resolved, fiscal policy needs to remain prudent, with the surplus allocated to paying down public debt while demographics remain favourable.