Canada’s economic outlook beset by uncertainty and recession risks for rest of year

Persistent economic uncertainty will negatively influence Canada’s outlook for the rest of 2025 as global trade tensions—and their wide-reaching consequences—continue unabated.

The erratic nature of U.S. trade policy and the unpredictable implementation and retraction of tariffs have soured Canada’s economic outlook. Recession fears grow as short-term inflation expectations rise, consumer sentiment deteriorates and investments falter despite low inflation and low interest rates.

The probability of a recession over the next 12 months has climbed to 65 per cent as Canada’s economy is expected to contract in the second and third quarters of this year.

These developments are the latest in a series of economic shocks threatening Canada this year. Diversifying interprovincial and international trade relationships, investing aggressively in infrastructure, and making long-overdue productivity enhancements are essential changes—otherwise, Canadian businesses risk obsolescence in the global marketplace.

A new federal government under Prime Minister Mark Carney could employ a strategy of fiscal stimulus to boost productivity, diversify trade and soften the blow of tariffs. This also presents an opportunity for Canadian businesses to build resilience for sustained future growth.

Unfortunately, many factors remain outside of Canada’s control. If U.S. tariffs extend to Canadian services, the odds of a recession could jump to a near certainty.

While Canada currently has a lower effective tariff rate compared to many other U.S. trade partners, policy uncertainty is decimating business sentiment.

The Bank of Canada, meanwhile, continues to prioritize maintaining price stability despite the pressures that come with a looming economic downturn. Two more interest rate cuts are expected this year, which would bring its policy rate to 2.25 per cent by the end of the year.

Inflation could surpass 3 per cent due to tariffs and subsequent supply chain disruptions before dipping again on weak consumer demand. Canada’s unemployment could rise to 7.5 per cent as investments slow and employers pull back on hiring as tariffs cause an economic slowdown.

Here is a look at what to expect economically in Canada for the second half of 2025.

All signs point to slower growth

Canada’s growth outlook is fraught with uncertainty, but all signs point to a significant slowdown in economic activity.

While the early months of 2025 enjoyed some momentum from the GST/HST holiday, restored price stability, falling interest rates and businesses pulling orders forward, the imposition of U.S. tariffs derailed any growth trajectory.

This year’s second quarter could see a moderate-to-sharp contraction in activity. The third quarter might see a modest contraction, while expansion could start again in the fourth quarter.

If U.S. tariffs remain relatively contained, as has mostly been the case for Canada, there will be economic stagnation—but Canada could narrowly avoid a full recession.

If U.S. tariffs become more widespread, Canada would likely experience a general recession. In this scenario, unemployment would spike as layoffs become widespread due to tariffs and falling investments.

Consumers are already cutting discretionary spending amid recession fears—and an actual recession, coupled with job losses, could exacerbate this situation and apply further downward pressure on inflation.

Should this come to pass, the path to recovery would be slow and arduous as Canada seeks to decouple itself from the U.S. economy. It could take up to a year for Canada’s gross domestic product (GDP) to return to Q1 2025 levels and growth would be nearly non-existent this year.

In any case, sectors dependent on exports will be hurt the most, including auto manufacturing, steel and aluminum production, and food manufacturing. Energy would be less affected as the current U.S. tariff rate is set at a lower 10 per cent.

Even if the current tariff situation continues as is, disruptions could cascade across Canada’s economy and affect industries like retail, tourism, restaurant dining, entertainment and real estate. Such widespread damage could threaten to trigger a general recession.

A drop in U.S. demand could inflict tremendous damage to Canada’s growth as it would result in lower demand for Canadian goods as well as services like travel and dining out. Weak population growth thanks to stricter immigration limits could also contribute to a slowdown in aggregate consumer spending. 

Canadian industries like financial services might be much better insulated, provided U.S. tariffs remain focused on merchandise.

To soften the blow of tariffs, the federal government is expected to employ fiscal stimulus—likely in the form of investments in infrastructure that helps build resilience in the long run.

Another silver lining could be the willingness of provincial and territorial governments to collaborate with Ottawa to eliminate interprovincial trade barriers. This could provide some tail winds for growth, offset some of the tariff pains and boost productivity by a few percentage points.

Tariffs still top of mind

Trade uncertainty is undeniably the defining challenge of 2025. The U.S. imposed tariffs on a wide range of Canadian exports, notably autos, steel, aluminum and goods not compliant with the countries’ free-trade agreement.

Tariffs are a tax on imports, generally aimed at protecting domestic industries and generating revenue. Importers pay the tariffs and most often pass on those costs to consumers; it’s estimated that over 90 per cent of tariffs paid are eventually passed on to consumers. Retailers in the U.S. are already showing tariffs as separate items on customer invoices.

On the positive side, strategic tariffs—such as those Japan applies to rice imports—can protect domestic industries and national security.

However, the sweeping and unpredictable nature of U.S. tariffs has caused widespread economic damage not only to Canada but also to the U.S. and the rest of the world—resulting in a global lose-lose scenario.

This is further evident in the threat of tariffs on services such as foreign films. For context, the U.S. has a global trade surplus when it comes to films. Such a tariff would be devastating for Canada, as Vancouver is one of the largest global hubs for film, video effects and animation production. Many films and shows set in U.S. cities are filmed across Canada, with post-production also taking place north of the border.

If tariffs on services become a reality, the recession odds become a near certainty.

There are some positives for Canada, including a series of U.S. exemptions which lower the effective tariff rate for Canadian exports to below 10 per cent. By comparison, the U.S. baseline tariff rate on imports from most countries is 10 per cent, with many countries facing a higher rate.

Tariffs raise the price of imports, which translates to lower demand for Canadian goods and increased pressure on jobs and investments. In March, Canadian exports to the U.S. fell 6.6 per cent—the largest drop since the COVID-19 pandemic—while imports from the U.S. fell 2.9 per cent.

At the same time, Canadian exports to other countries jumped 24.8 per cent during that same time frame, driven by commodities like oil and gold. Exports to the U.S. are expected to keep falling while exports to other countries could rise as Canadian businesses further explore the global trade environment. This is an encouraging sign that Canadian businesses are diversifying away from the U.S. and expanding into new markets.

The sheer degree of uncertainty is as harmful as tariffs themselves—which is further illustrated by all-time highs in Canada’s economic policy uncertainty.

It is extremely challenging for businesses to plan investments and manage supply chains amid rising input costs. Meanwhile, consumers in Canada and the U.S. are pulling back on spending, which hurts demand and thus growth. 

Canada, whose economy is deeply intertwined with the U.S., bears an oversized burden. Diversification will take time, whether it will involve finding alternative suppliers and consumers or rerouting shipments from Asia directly to Canada instead of through the U.S.