Canada’s economy is entering the final quarter of 2025 with weakened momentum, though analysts increasingly believe a severe recession can be avoided. While short-term challenges persist, including trade tensions, rising unemployment, and sluggish productivity, many forecasters anticipate a gradual recovery beginning in 2026.
“Domestic activity was robust in the second quarter, but we don’t expect that momentum to carry into year-end,” said Tiago Figueiredo, macro strategist at Desjardins. He noted that slowing population growth and ongoing mortgage renewals are likely to constrain economic activity. Although previous interest rate cuts have provided some support, “the recent rise in global long-term rates is offsetting some of those benefits,” he added.
Analysts expect growth to weaken further in the second half of the year, with GDP averaging near zero and the slowdown spreading beyond trade-exposed sectors into services and other areas. Labor market data already shows deceleration in job creation across multiple industries.
Dawn Desjardins, chief economist at Deloitte Canada, warned that consumer spending—so far resilient—may decline in Q4. “We anticipate weaker-than-usual spending due to softening labor conditions and low confidence,” she said in a recent report. She highlighted that immigration caps led to negligible population growth in Q2, a trend expected to continue into 2026 due to reduced government targets. This could result in weaker consumption and a strained labor market.
“With both employment and labor force participation weakening, the unemployment rate—currently at 7.1%—is unlikely to rise sharply, but conditions will remain tight in the near term,” Desjardins cautioned. She projects real GDP growth of 1.3% in 2025 and 1.7% in 2026.
Despite near-term pessimism, some expect improvement in 2026. Deloitte’s Desjardins believes the foundation is being laid: “The Bank of Canada is expected to provide additional stimulus to boost confidence.” While sector-specific tariffs will affect manufacturing, Canada’s average tariff burden remains low compared to other nations, limiting broader economic damage. A pickup in growth is expected due to greater fiscal clarity, monetary easing, and the completion of trade sector adjustments.
Figueiredo anticipates structural shifts in 2026, with economic growth becoming more domestically focused amid global fragmentation. Increased public investment in defense and infrastructure, as promised by the Carney government, could drive medium-term expansion. “We’ve moved beyond declarations,” he said. “Execution will be key.” Most of the projected 2026 growth stems from public spending.
Citi economist Veronica Clark offers a more cautious view, expecting demand weakness to persist into 2026. “The output gap is widening as unemployment rises,” she noted.
The bond market outlook remains favorable. With inflation easing and growth slowing, the Bank of Canada is likely to continue cutting rates. “Lower inflation and weaker growth are positive for government bonds,” said Konstantin Boehmer, head of fixed income at Mackenzie Investments. He expects the disinflation and weak-growth trend to continue, supporting bond performance.
Boehmer also highlighted diverging U.S. and Canadian monetary policies, with the Fed expected to cut rates while the Bank of Canada holds steady, leading to outperformance of Canadian bonds, especially those maturing under 10 years. He sees strong potential in high-quality Canadian government bonds and local-currency emerging markets like Mexico, Brazil, and South Africa.
Nick Rees, head of macro research at Monex Canada, forecasts the Canadian dollar will strengthen against the U.S. dollar by year-end, reaching USD/CAD 1.36 from 1.40. This is based on expectations that the Fed will cut rates twice more while the Bank of Canada holds. However, he notes the loonie may underperform against other G10 currencies due to Canada’s close economic ties to the U.S., where slowdown risks are growing.
A major risk ahead is the upcoming review of the USMCA trade agreement in July 2026. Given the Trump administration’s past approach, Rees warns this could weigh on the Canadian dollar.
Regarding monetary policy, analysts expect further rate cuts in Q4 2025 and into 2026, contingent on inflation control. Figueiredo forecasts the policy rate could fall to 2.00%, depending on progress in core inflation. Clark expects a cut in October and signals of more to come. Boehmer predicts two cuts in 2025 but doubts the Bank will go as low as 2.00% if the Fed cuts only once.
— news from Morningstar Canada
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Q4 2025 Economic Outlook: Cautious Optimism
Key Takeaways n nCanada’s economic weakness could persist for the remainder of the year. n nAnalysts see a resurgence in the next year as trade uncertainty abates and growth picks up. n nThe Canadian dollar is poised for a stronger finish against the US dollar. n nLow interest rates will keep the bond markets humming for the foreseeable future. n nAfter three tumultuous quarters in which the economy has faced steep US tariffs, fears of recession, labor market contraction, and a stalled GDP, Canada is entering the final quarter of 2025 bruised but with a growing consensus that the country will avoid a hard recession. While not much is likely to change in the short term, some do see the potential for an uptick in 2026. Before then, economists warn that tariffs, mounting unemployment, and sagging productivity could further stifle business investment and consumption, as well as drag on the economy. n n“Domestic activity was strong in the second quarter, but we don’t expect that strength to continue into year-end,” says Tiago Figueiredo, macro strategist at Desjardins. “Slowing population growth and ongoing mortgage renewals should continue to keep economic activity relatively muted.” He acknowledges that the economy is likely getting some boost from past rate cuts. Still, “the recent rise in global long-term interest rates is dampening some of the impact from [those] cuts.” n nEconomy to End the Year With a Whimper n nSupportive Bank of Canada monetary policy notwithstanding, analysts anticipate sufficient headwinds to support their less-than-cheery year-end outlook. “I expect further slowing in growth in the second half, GDP averaging around flat, and importantly, the slowdown in activity not just concentrated in trade-exposed sectors but broadening to the rest of the economy, such as various services,” cautions Citi economist Veronica Clark. She adds that recent labor market data for the second half of the year has already shown more deceleration in job growth from these sectors. n nDawn Desjardins, chief economist at Deloitte Canada, expects consumer spending, which has remained resilient thus far, to begin to wilt in the fourth quarter. “We are wary that the softening in the labor market and low confidence will result in weaker than usual spending for the remainder of this year,” she writes in a recent report. Capping immigration “resulted in negligible population growth in the second quarter, and this trend will continue in 2026, given the government’s downsizing of its targets,” she says. The result could be a double whammy of crimped consumption and a deteriorating labor market. n n“With both employment and the labor force softening, the unemployment rate, which hit a recent high of 7.1% in August, is unlikely to move much higher, [but] labor market conditions will remain strained in the near-term,” Desjardins warns. She forecasts real GDP to gain 1.3% this year and 1.7% next year. n nA Rebound on the Horizon n nDespite a grim forecast for the near term, some observers expect things to start looking up in 2026. Deloitte’s Desjardins says the groundwork is laid: “The Bank of Canada is expected to provide some additional stimulus to boost consumer and business confidence.” Although sector-specific tariffs will continue to impact manufacturing industries, Canada is facing low overall average tariffs compared with other countries, which she says is ”minimizing the size of the economic damage.” The outlook for a pickup in growth next year is also underpinned by the prospect of increased “clarity on the fiscal front, monetary stimulus and the expectation that the trade sector adjustments will largely be behind us,” Desjardins says. n nMeanwhile, Desjardins’ Figueiredo expects the economy to undergo some notable structural changes in 2026. “With globalization under pressure, economic growth is set to be more concentrated in the domestic economy,” he says. A key factor that could drive Canada’s medium-term growth is the Carney government making good on its promise of increased defense and infrastructure spending. “We’re past the point of bold declarations,” says Figueiredo, adding that “what will matter going forward is the nitty-gritty of executing on these projects.” Most of the pickup in the “[economic] activity we’ve penciled into 2026 is driven by public investments.” n nCiti’s Clark strikes a contrarian note, expecting Canada’s economic woes to persist. “I think the slowing in demand will be with us into 2026,” she says, stressing that the “output gap is already widening further with the unemployment rate rising.” n nBright Prospects for the Bond Market n nThe fourth quarter is expected to be solid for Canadian fixed income. With growth softening and inflation pressures receding, odds are high that the Bank of Canada continues its rate-cutting cycle. “Lower and declining inflation and lower and declining [economic] growth are both very positive for government bonds,” says Konstantin Boehmer, head of fixed income and portfolio manager at Mackenzie Investments. “Absent a truly game-changing federal budget, which we do not expect, the disinflation and weak-growth trend should persist, supporting bonds.” n nBoehmer explains that such a budget would include things like functional transportation for people and goods, reliable and affordable grid and energy systems, faster approval for productive projects, substantial investments in schools and trade skills, and digital infrastructure that is modern and secure, collectively driving private capital to follow. Boehmer also points to the divergence between US and Canadian monetary policies, which has led to “Canadian bonds outperforming US bonds, especially those under 10 years of maturity.” n nHe sees attractive opportunities for bond investors beyond the fourth quarter, through 2026. “We’re constructive on high-quality bonds in Canada, particularly government bonds in the front end and belly of the curve [out to about 10 years],” he says. Long-dated US inflation-linked bonds are also “interesting investments.” Further afield, Boehmer is particularly optimistic about opportunities in “local-currency emerging markets, especially Mexico, Brazil, and South Africa, where real yields and policy credibility remain appealing.” n nThe Canadian Dollar Claws Higher n nNick Rees, head of macro research at Monex Canada, forecasts the Canadian dollar will end the year stronger against the US dollar. His outlook is underpinned by the expectation that the Bank of Canada holds its policy rate in October while the US Federal Reserve cuts rates at its two remaining meetings this year. “We see growing risks that the Fed will cut rates too far, based on the FOMC’s recent decisions, though this poses upside risks for USD/CAD both via a weaker greenback and through positive growth spillovers,” he explains. n nRees also points to uncertainties arising from the ongoing US government shutdown and the upcoming Canadian federal budget. However, he assures that “on balance, we think both tilt risks in favor of [the Canadian dollar with] year-end USD/CAD call of C$1.36” from the current C$1.40. n nEven though its upside story continues past the fourth quarter, Rees projects the Canadian dollar will “underwhelm against the broader G10 complex.” This is because the Canadian economy remains too tightly bound to the United States, “where we expect to see growing signs of slowdown, for the loonie to make outsized gains.” n nThe other major looming risk is the review of the USMCA continental free trade agreement, due next July. “Given the recent approach of the Trump administration to such negotiations, we suspect this will likely prove a headwind for the loonie, once the process kicks off in earnest,” Rees cautions. n nBank of Canada Policy Predictions n nAnalysts expect the Bank of Canada to continue to cut rates in the fourth quarter, and likely in 2026, to stimulate growth, provided inflation remains in check. “Monetary policy remains the immediate and flexible lever to stabilize growth,” says Desjardins’ Figueiredo, who forecasts the central bank will lower the policy rate to a trough of 2.00%. The timing of that easing will depend on “continued progress on core inflation measures,” he says, but “we don’t believe that there is an inflation problem in Canada.” n nCiti’s Clark says policymakers will still primarily be concerned about inflation and be cautious of turning too dovish. She forecasts “a cut in October” and a policy shift indicating more cuts to follow. “Eventually, policy rates falling below neutral will help boost demand again, as well as more fiscal support into 2026,” she says. n nBoehmer forecasts two additional cuts in 2025 but says, “the Bank of Canada is likely uncomfortable taking the policy rate to 2.00%, particularly if the US Federal Reserve delivers only one more cut in 2025, which is our base case.”