The Canadian economy slowed at the end of last year but has since rebounded and is still operating close to full capacity. It is expected to grow at rates above potential over the projection period, driving unemployment further below its estimated structural rate. Nevertheless, headline inflation is likely to decelerate significantly in the second half of 2006, reflecting a cut in the federal Goods and Services Tax, but should steadily move up to the upper limit of the monetary policy target range next year. In the context of rising inflationary pressures and buoyant economic growth, the Bank of Canada should continue with its tightening cycle. At the same time, fiscal settings at all levels of government should remain prudent and the federal government should focus on reducing the debt burden before ageing pressures accumulate.