Canada’s economy set to resume modest growth despite global volatility

To say that Canada’s economy and its financial markets have been exposed to a relentless stream of external shocks is an understatement.

First there were the tariffs of 2025 and the attempts to rebalance North American trade, followed by the global energy shock this year. Two consecutive quarters of negative GDP growth—the fourth quarter of 2025 and the first quarter of 2026—should come as little surprise.

 While we do not expect the economy to fall into recession this year, any estimates of growth still carry significant uncertainty.

The consensus among economists and the Bank of Canada is for positive GDP growth to resume during the second half of 2026, even as the economy deals with the lagged effects of the energy shock.

We expect increased employment in the energy sector to offset at least some of the negative effects of inflation on consumer spending.

While tariffs have increased costs for everyone, businesses were able to retain U.S. customers and started taking steps to expand their reach beyond North America. And as a net exporter of oil, Canada has the means to withstand the initial cutoff of global petroleum products.

To that end, the International Monetary Fund (IMF) expects Canada to have the second-fastest-growing economy among the G7 nations this year, just behind the U.S.

However, ongoing disruptions will negatively affect spending and will be felt most significantly by lower-income households due to the importance of petroleum to global supply chains for transportation, heating, medicine, food and everyday consumer items.

If the current ceasefire in the Middle East holds, the next inflection point would be the July 1 deadline for continuing the Canada-United States-Mexico Agreement (CUSMA) on free trade.

It appears the U.S. does not intend to renew the agreement—for now—as the current administration would prefer annual trade negotiations instead. But this will not disrupt the flow of trade or the broader economy this year.

A wait-and-see approach to monetary policy

The double body blow of tariffs and the more recent disruption to the global flow of oil has inserted unprecedented levels of uncertainty into the normal give and take of North America’s economic and financial activity.

While the financial markets in Canada and the U.S. may appear to have taken a blasé stance on the energy shock, we might better characterize it as a wait-and-see approach based on the level of uncertainty in U.S. policy.

In our opinion, there is a non-zero risk that the energy and logistics sectors will experience a delayed reaction to the mounting stress, which could then affect Canada’s economy through the inflation channel.

Can Canada’s status as an oil exporter stave off an energy shock?

The dampened supply of petroleum-based products will undoubtedly cause a global increase in inflation, followed by diminished consumer spending and slower economic growth.

Canada’s status as a net exporter of oil is unlikely to spare its households from rising energy prices. Canada’s consumer price index inflation rate has been tightly connected to the global benchmark price of Brent oil over the past 10 years; the lagged effect of the increase in the Brent price on fertilizers, food and clothing remains a direct threat to Canadian households.

The median forecast among economists surveyed by Bloomberg is for Canada’s inflation rate to increase to 2.9 per cent in the second quarter of 2026—the top of the Bank of Canada’s target range—with estimates ranging from 2.2 per cent to 3.2 per cent.

The low end of those estimates seems dependent on a quick rebuild of the Middle East supply chain—and perhaps a high regard for the energy self-sufficiency of the North American economy.

As a result, we can expect diminished corporate earnings and slower wage growth in both nominal and inflation-adjusted terms—which would lead to diminished real income and spending.

The financial sector and economic growth

Higher inflation will undoubtedly be met with tightening of financial conditions as the Bank of Canada and the U.S. Federal Reserve look to restore price stability.

Monetary policy is transmitted to the economy via financial conditions. The RSM Canada Financial Conditions Index, which estimates the amount of risk priced into financial assets, has drifted lower to just 0.4 standard deviations above neutral. While this implies a level of accommodation necessary for investment and economic growth, the drift lower suggests a measure of caution.

Financial conditions have been buoyed by range trading in the bond market, modest support from the commodity market and the robust performance of the stock market.

We think the interest rate markets warrant the most attention, as developed economies tighten monetary policy in response to worldwide energy shortages and higher inflation.

Higher overnight rates will have a more subtle effect on the cost of long-term capital. Along with the rise in inflation, this will dampen the propensity to invest and become a drag on economic growth.

While an extended energy shock could ultimately push the economy toward recession and therefore require lower interest rates, the bond market is paying attention to the immediate threat of higher inflation. This concern had long-term interest rates in the U.S. and Canada trading at the top of their recent trading ranges before they eased following the announcement of a ceasefire in the Middle East.

An uncertain snapshot of economic growth

Canada avoided a recession in 2025 despite the tariffs. Its economy looks healthy enough to have withstood the moderate energy shock so far.

The consensus among economists surveyed by Bloomberg is for Canada’s economy to grow by 1.1 per cent in 2026 on the back of household consumption. Growth is expected to return to its potential of 1.7 per cent per year in 2027 and 1.9 per cent in 2028.

One bright note is that unfilled manufacturing orders that had been decelerating in 2025 are moving higher again in 2026, increasing by 12.6 per cent in April.

In the labour market, the unemployment rate moderated to as low as 6.5 per cent in the first months of 2026 after reaching 7.1 per cent last September. Both weekly and hourly wages are growing faster than inflation, lending support to household incomes and spending.

In the external sector, however, the Canadian government expects further decreases in exports as U.S. tariffs continue to weigh on demand for Canadian steel, aluminum, copper, lumber and autos.

In response, firms appear to have begun diversifying their supply chains, with exporters reporting stable sales to U.S. customers in the first quarter of 2026 alongside a slight increase in sales to non-U.S. customers.

Since Canadian consumers are still buying goods because of strong household balance sheets and prior declines in interest rates, exporters are not yet fully motivated to diversify because their bottom lines haven’t largely been affected

We expect Canada’s nominal GDP to grow along with the price of commodities affected by global supply chain disruptions. According to the federal government’s budget report, the oil and gas sector is an integral part of the Canadian economy, accounting for about five per cent of the country’s GDP, 10 per cent of its business investment and 13 per cent of exports.

But again, the cutoff of petroleum products will have a widespread effect on input prices and inflation, thereby dampening economic growth in real (inflation-adjusted) terms as well as growth in real income and real wages.

The Bank of Canada’s April projections include a slowdown in potential output growth, with U.S. tariffs driving a structural adjustment in the Canadian economy. The economy is expected to pick up as it further adapts to the new trade regime, with productivity gains continuing and subdued population growth gradually picking up.

While the government’s 2025 federal budget outlined its plan to improve lives by spurring investment and growth in the future, fiscal programs come at a cost. The budget’s anticipated fiscal position will push public debt up to 42 per cent by fiscal year 2028−2029.

Unfunded government spending, if not balanced by higher levels of growth and tax revenue, will eventually become a drag on growth.

Trade tensions remain

We expect Canada’s economy to continue rolling on despite the ongoing U.S. tariffs and the uncertain future of CUSMA. However, the tariffs are expected to have a persistent negative effect on Canada’s economic activity, according to recent Bank of Canada analysis.

While there is clearly unease over the status of the CUSMA negotiations and how easily they have been sidetracked by industry concerns and personal affronts, previous negotiation episodes have been marked by bluster before a return to the status quo.

Unfortunately, there is no guarantee of that happening now or in the future.

Interprovincial trade barriers also remain a notable obstacle to national economic growth. According to the IMF, removing them could offer one of the most powerful—and least fiscally costly—levers to raise productivity, strengthen resilience and support inclusive growth.

Amid external volatility, especially if it remains endemic, bolstering domestic growth is a sound strategy to help mitigate any further disruptions.