Tariffs and trade uncertainty remain the most prominent threats to Canada’s economy, with wide-ranging implications for growth, inflation, employment and monetary policy.
As the first half of 2025 showed, trade tensions hurt business and consumer sentiment as well as hiring and consumer spending.
The probability of a recession in Canada in the next 12 months is more or less a coin flip at 55 per cent. Should a recession occur, the economy would likely contract in the second and third quarters before expanding in the last quarter, and growth this year would slow to 1 per cent.
The Bank of Canada prioritizes price stability as a source of consistency and confidence in an environment of heightened uncertainty. Two more interest rate cuts are expected this year, which would bring the policy rate to 2.25 per cent—the bottom end of the neutral rate range—by December. Should a sharp downturn occur, rate cuts will come faster.
There are both upward and downward pressures on prices in the months ahead. Trade-related supply chain disruptions could drive up prices as businesses navigate a new reality and find alternative transportation options, suppliers and customers.
Since Canada dropped some of its retaliatory tariffs on U.S. imports, while its other measures were implemented with availability of domestic substitutes in mind, the inflationary impact of retaliatory tariffs would be minimal.
Meanwhile, weaker domestic and U.S. demand places downward pressure on prices, especially as households reduce spending. While core inflation is elevated, an economic downturn would ease price pressures.
As hiring freezes and layoffs spread, consumer confidence is slipping. This is particularly evident in housing as prospective buyers sit on the sideline, which meant a potentially promising spring housing market did not materialize.
While uncertainty persists, it looks more likely that a scenario with lower tariff rates despite a bumpy road to get there will pan out—meaning Canada could narrowly avoid a recession.
The share of Canadian goods compliant with the Canada-United States-Mexico Agreement (CUSMA) surged from 38 per cent in 2024 to over 50 per cent in April.
Since CUSMA-compliant goods are exempt from U.S. tariffs, expect this share to keep rising as the tax-free benefit of ensuring compliance is worth the administrative burden. Most Canadian exports to the U.S. managed to avoid tariffs in April.
With CUSMA exemptions, the current effective tariff rate for Canadian exports into the U.S. is at 2.3 per cent—among the lowest in the world. Jobs in trade saw increases in May after plunging in April; this suggests the trade outlook for Canadian goods is not entirely doomed.
The Bank of Canada will closely watch movements of trade, consumer spending and businesses investments while monitoring soft data from travel and trucking in the months ahead. This will inform how it determines the degree of economic slowdown—and consequently the direction and range of monetary policy in the months ahead.
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