OECD Economic Outlook, Volume 2025 Issue 2

Canada

GDP growth is projected to strengthen over 2026 and 2027, reaching 1.3% and 1.7% respectively, as the economy recovers from the trade slowdown in 2025 following higher US tariffs. A rebound in trade is expected to support a gradual pickup in business investment, while household consumption picks up as uncertainty fades. Headline inflation is expected to remain close to 2%, with a temporary uptick in 2026 as the downward impact of the fuel charge removal disappears. Core inflation is projected to continue moderating, reflecting lower wage growth and a widening output gap.

With inflation pressures easing, the Bank of Canada has resumed rate cuts, but no further cuts are expected at this stage. Fiscal policy has become more accommodative, reflecting targeted support for sectors most affected by tariffs, broader tax reductions and increased defence and infrastructure spending. A key policy priority remains strengthening Canada’s weak productivity growth by fostering investment, promoting innovation, and advancing digitalisation.

Economic activity has moderated amid headwinds from higher tariffs

Real GDP contracted by 0.4% in the second quarter of 2025, following solid growth in the first quarter (+0.5%). The downturn was driven by sharp declines in exports and business investment, as tariffs on trade with the United States took effect. Strong household consumption growth, supported by a marked decline in the savings ratio, and inventory accumulation provided some offsetting support to GDP. Residential investment also rebounded after a previous decline. Leading indicators suggest continued weakness in the third quarter. Business and consumer confidence remain subdued, despite a slight recovery from mid-year lows. The labour market has weakened alongside the broader slowdown, with unemployment reaching 6.9% in October 2025. Headline inflation stood at 2.2% in October 2025. Upward price pressures from tariffs on headline inflation are being offset by excess supply and the removal of the federal fuel charge. Core inflation rose to 2.7%.

Canada 1

1. Year-on-year growth rates.

Source: OECD Economic Outlook 118 database.

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Canada: Demand, output and prices

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Canada 2

1. Refers to population aged 15 years and over.

2. As percentage of potential GDP.

Source: Statistics Canada; and OECD Economic Outlook 118 database.

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The Canadian economy has slowed due to higher US tariffs, reflecting the depth of bilateral trade linkages. Nonetheless, signs of resilience have emerged, and the contraction appears broadly contained. Canada removed most retaliatory tariffs in September 2025, except on steel, aluminium, copper and US-sourced automotive content, which is expected to ease inflationary pressures and further limit the drag on economic activity. US tariff rates rose to 35% in August 2025 (up from 25%) for non-energy goods outside the United States-Mexico-Canada Agreement (USMCA). However, effective USMCA compliance has increased over recent months, with around 80% of Canadian exports now benefiting from preferential tariff-free treatment. A slightly higher oil price should also provide modest support to the Canadian economy.

Macroeconomic policies are set to ease as growth slows and inflation remains around target

The Bank of Canada lowered interest rates between June 2024 and March 2025 as inflation approached its 2% target. Rate cuts were then paused amid tariff-related uncertainty, before two further 25 basis point cuts to 2.25% were implemented in September and October 2025. These cuts reflect subsiding inflationary impacts from tariffs, following the removal of most of the retaliatory tariffs, and a broader easing of underlying price pressures. The policy rate is expected to remain unchanged at its current level. The pass‑through from lower policy rates to bank lending rates has advanced, and its effects on the real economy are expected to become more visible in 2026, as uncertainty diminishes.

The general government budget balance had a deficit of 2.0% of GDP in 2024, driven by a one-off compensation payment (0.7% of GDP), higher interest payments and increased discretionary spending, particularly on social programmes and affordable housing. The expiry of the 2024 one-off payment (for those harmed by underfunding of First Nations Child and Family Services) will slightly reduce the headline deficit in 2025, which is partly offset by a deteriorating underlying balance due to fiscal support for sectors most affected by tariffs and broader tax cuts. A sustained increase in defence spending of about 0.2% of GDP will also weigh on the fiscal balance. Some further mild easing is expected in 2026, driven partly by higher infrastructure investment, while a more neutral stance is projected for 2027.

Activity is poised to recover from the trade-induced slowdown

A gradual recovery is expected to begin in late 2025 and continue through 2026, as the economy adjusts to the new trade environment and uncertainty diminishes. Exports should rebound from the lower 2025 levels as the highest-tariffed sectors adjust, supporting a gradual pickup in business investment. Household consumption is projected to expand only modestly in the latter half of 2025 due to weaker income prospects before firming again in 2026 and 2027 as incomes strengthen. Residential investment is set to gather momentum in 2026, supported by housing support measures and lower lending rates. The labour market is expected to improve gradually over 2026 and 2027. Headline inflation is projected to remain close to 2%, with a slight uptick in the second quarter of 2026 as the dampening effect of the federal fuel charge removal disappears. Core inflation is expected to moderate further to 2%, reflecting subdued wage growth and a widening output gap.

Risks to the outlook are broadly balanced. A renewed rise in trade uncertainty could delay the recovery in business investment and exports. A sharper-than-expected deterioration in labour market conditions, driven by a stronger impact from trade, would weigh on household incomes and dampen domestic demand. On the upside, household consumption and residential investment could outperform expectations, particularly if households draw more heavily on accumulated savings. Overall, uncertainty remains elevated, notably due to the unclear trajectory of US tariffs and the upcoming mid-2026 review of the USMCA agreement.

Reforms are needed to strengthen productivity growth

Policy priorities in Canada should focus on revitalising subdued productivity growth. This entails promoting investment in productive assets, particularly digital technologies, and strengthening innovation. Progress in improving the internal market through the removal of Canadian Free Trade Agreement (CFTA) exemptions is welcome and should continue. Labour mobility would further benefit from nationwide recognition of professional qualifications, including foreign credentials. Entry barriers in services and network industries also remain elevated and should be lowered, for example by reducing foreign-ownership restrictions in telecommunications. Existing R&D tax incentives could be streamlined for smaller and larger firms and complemented by more direct support. Expanding the supply of housing, especially affordable rental housing, also remains a priority.