OECD Economic Outlook, Volume 2025 Issue 1

Canada

GDP growth is projected to weaken from 1.5% in 2024 to 1.0% in 2025 and 1.1% in 2026 due to trade tensions with the United States. Exports and business investment are expected to decline in 2025, while deteriorating employment prospects are expected to weigh on household consumption. Headline inflation will rise slightly, as the impact of higher tariffs on consumer prices is partially offset by lower energy prices due to the removal of the fuel charge. Core inflation will increase for a period before falling back towards 2% next year. Uncertainty about tariff levels and the impact on the Canadian economy remains high.

The Bank of Canada has reduced interest rates to 2.75%, with further modest cuts expected this year. However, inflationary pressures from higher tariffs will require a more cautious approach to lowering interest rates. Increased government spending, particularly on housing affordability and new social programmes, has recently worsened the general government balance, although it had previously been in surplus. A key policy priority remains the need to enhance Canada’s weak productivity performance by removing internal barriers to trade and labour mobility, and by strengthening investment and innovation.

GDP growth was robust in early 2025, but the outlook has deteriorated

Real GDP grew robustly by 0.6% in the last quarter of 2024. Private consumption benefited from the temporary reductions in the goods and services tax (GST) and harmonised sales tax (HST) on qualifying goods. Housing investment continued to recover, and business investment rebounded after a previous quarterly decline. Leading indicators show that economic momentum continued into early 2025, with GDP growing by 0.4% in the first quarter of 2025 according to the flash estimate. However, the outlook has worsened since then due to rising trade tensions with the United States. Business and consumer sentiment have deteriorated, and policy uncertainty has increased. The labour market showed renewed signs of weakening in April, with the unemployment rate rising to 6.9%. Consumer price inflation eased to 1.7% in April, down from 2.3% in March, driven by lower energy prices following the removal of the federal fuel charge and the decline in oil prices. Core inflation increased to 2.6% in April, after 2.4% in March.

Since February 2025, trade tensions and increased tariffs on imports to the United States heavily weigh on Canada’s external perspectives, given the interlinkages of the two economies. The heightened uncertainty about tariff levels also burdens long-term spending and investment decisions. For Canada, the tariffs include a 25% tariff on goods and a 10% tariff on energy and potash for imports into the United States that do not fall under the United States-Mexico-Canada Agreement (USMCA). The projections assume that about 50% of imports do not fall under the agreement. Additionally, they incorporate the 25% tariff rate on steel and aluminium products and the 25% tariff rate on non-US content in USMCA-compliant automobiles. They also account for the counter measures announced by the Canadian government. The broader rise in US tariffs will also dampen external demand. The increased volatility of financial conditions will also adversely impact the near-term outlook.

Canada 1

Source: OECD Economic Outlook 117 database; and S&P Global.

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Canada: Demand, output and prices

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Canada 2

1. Year-on-year growth rates.

2. Refers to population aged 15 years and over.

Source: OECD Economic Outlook 117 database; and Statistics Canada.

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Monetary policy has eased, and fiscal policy will be supportive in 2025

The Bank of Canada began to lower interest rates in June 2024, with a total decline of 225 basis points as of mid-April 2025, bringing the policy rate to 2.75%. The projection includes a further 50 basis point reduction in the rate during 2025. The central bank will need to carefully balance the opposing impacts on inflation from tariffs: upward pressure from higher import prices and downward pressure from lower demand. Quantitative tightening, i.e. net asset sales, ended in March. The transmission of lower policy rates to lending rates has progressed, and its impact on the real economy is expected to become more apparent in 2026, as other uncertainty factors wane.

The general government budget balance has shifted from a small surplus of 0.1% of GDP in 2023 to a deficit of 2.1% of GDP in 2024, driven by a one-off compensation payment of about 0.7% of GDP, higher interest payments and increased discretionary spending, particularly on new social programmes and affordable housing. The headline deficit is set to improve in 2025, while the underlying primary balance will slightly weaken. The removal of the federal fuel charge on April 1 will have a broadly neutral budgetary impact, as its revenues were principally recycled back to households and businesses through the "Canada Carbon Rebate”. For 2026, a further improvement in the headline balance is assumed, helped by mild fiscal tightening.

GDP growth is expected to slow due to trade tensions

After still robust GDP growth in the first quarter of 2025, GDP growth is expected to drop in the second quarter due to sharply falling exports to the United States due to higher tariffs. Household consumption and business investment will also be affected negatively by trade disruptions and high uncertainty. Housing investment is anticipated to remain broadly flat in the first half of 2025, weighed down by elevated uncertainty. Imports are expected to decline less than exports, resulting in a negative net export contribution to GDP growth in 2025. Labour market conditions will further deteriorate in 2025. In 2026, GDP is projected to slowly recover as the economy adjusts to the new tariff environment. Lower interest rates will support business investment and household consumption as uncertainty declines. However, slower population growth will moderate aggregate consumption growth. Consumer price inflation is expected to be pushed upwards by higher tariffs, which will increase import prices. However, starting April 1, this will be partly counterbalanced by lower energy prices resulting from the removal of the federal fuel charge. Core inflation is anticipated to increase more sharply in 2025 before gradually declining in the course of 2026.

Substantial risks remain, reflecting the highly uncertain situation. Externally, there are risks regarding additional tariffs on Canadian imports to the United States and the potential lifting of the USMCA exemption. Conversely, tariff reductions for Canada could improve economic prospects. US tariffs on other countries could rise or remain at their current levels after the current 90-day suspension period, affecting external demand. There is also significant uncertainty regarding how tariffs will pass through to the Canadian economy, given the magnitude of the tariffs and the strong interconnectedness of North American supply chains. Domestically, new reform measures by the incoming government present upside risks to GDP, while stronger-than-anticipated spillover effects from trade tensions to domestic financial conditions could pose downside risks.

Reforms could strengthen productivity and internal markets

Trade tensions have highlighted Canada's dependence on the US economy. While the United States remains an important trading partner, Canada should continue to diversify its export markets. Furthermore, Canada can enhance its productivity performance and strengthen internal markets. High regulatory barriers on interprovincial trade should be reduced by expanding the scope of the Canadian Free Trade Agreement. A Canada-wide recognition of foreign credentials could improve labour mobility for immigrants. There is also room to strengthen innovation and competition. Existing R&D tax incentives should be streamlined for both smaller and larger companies and include more direct support. The competitive environment for digital and telecommunication businesses could be further strengthened. The government could also increase investment in infrastructure. Finally, the removal of the federal fuel charge will necessitate a reassessment of Canada’s carbon emissions reduction strategy.