Canada’s economy: The light at the end of the tunnel
August 28, 2025
Last week, OMERS Economic Research team gave an internal presentation on the Canadian economy and what may lie ahead. The team, led by frequent guest of this series, Executive Vice President Robert Lavigne, regularly provides OMERS with macroeconomic and financial markets analysis, country assessments and long-term strategic views. I thought it might be helpful to share the basis of their presentation here.
Discussions on the Canadian economy seem to be everywhere we look right now. This focus makes sense, given the increased turbulence and uncertainty that have characterized the last few years, and particularly the last few months. With trade, geopolitics and economic policies up in the air, it’s not surprising that better understanding Canada’s macroeconomic outlook is top of mind for many Canadians.
A prolonged period of weakness
Ever since the Bank of Canada’s significant rate increases in 2022, the Canadian economy has endured a challenging stretch. Domestic demand (meaning both consumption and investment) has remained weak, with only a brief reprieve in 2024 as rate cuts provided some relief. However, this positive momentum stalled again at the outset of 2025, largely attributed to the uncertainty surrounding U.S. policy under the Trump administration, including the threat of new tariffs and shifting rhetoric.
This environment of uncertainty is not unique to Canada. The U.S. has also experienced a cooling of growth, though the inflation picture diverges: Canadian inflation is easing, whereas U.S. inflation appears to be accelerating, partly due to tariff impacts. Thus, while Canada faces the risk of stagnation, the U.S. is contending with elements of stagflation.
Uncertainty freezes investment
The pervasive uncertainty, which echoes levels last seen during the COVID-19 pandemic, has had a chilling effect on business sentiment in both countries. Surveys indicate that firms, unsure of future trade arrangements and policy directions, have reduced their capital expenditure plans and pulled back on hiring. This has contributed to a more subdued labour market, with Canadian unemployment on the rise as more people struggle to find jobs.
The jobless rate rose to nearly 7% in Canada as hiring came to a near standstill this year. The U.S. has also seen a substantial slowdown in hiring, but the unemployment rate has barely budged, remaining steady at around 4%. We estimate that tighter immigration policy has led to a contraction in the U.S. labour force, which has kept the job market tighter south of the border.
Trade and fiscal policy: sources of optimism
Despite these major headwinds, there are reasons for cautious optimism. First, a significant portion of Canadian exports to the U.S. remain exempt from new tariffs thanks to the USMCA (also known as CUSMA). While some sectors face increased tariff exposure, the effective tariff rate on Canadian goods remains relatively low, and any resolution or clarification of trade agreements (as we saw last week when Canada removed retaliatory tariffs on CUSMA-compliant U.S. goods) could stimulate investment and economic activity. Still, with Canada not yet having concluded tariff negotiations with the US, the trade outlook could cut two ways.
Secondly, fiscal policy is set to provide meaningful support. Provincial budgets for 2025 include stimulus measures equivalent to about 1% of GDP, a sizeable figure aimed at offsetting the negative effects of trade conflicts. The federal government has also introduced tax cuts and signaled further stimulus in the forthcoming budget. In the short run, these measures should help counteract some of the economic drag from tariffs. Canada’s longer-term outlook will depend on the success of policy initiatives such as fast-tracking national infrastructure projects, increasing military spending, reducing intra-provincial trade barriers and encouraging export diversification.
On the monetary front, the Bank of Canada is expected to cut rates once more in late 2025, responding to persistent economic weakness. However, the scope for further easing is limited by still elevated core inflation and the imminent arrival of fiscal stimulus.
Last week’s Jackson Hole conference was potentially pivotal, as U.S. Federal Reserve Fed Chair Jerome Powell was seen as leaning towards future rate cuts. While markets are pricing in significant easing, the case is not necessarily compelling. The Fed faces rising tariff-induced inflation and a relatively tight labour market, leaving little room for aggressive rate cuts, despite persistent political pressures from the Trump Administration.
The Canadian dollar: near-term stability, medium-term optimism
The Canadian dollar (CAD) has depreciated significantly against the U.S. dollar over the past two years, benefitting exporters and Canadian investors with foreign holdings but posing challenges for travellers and importers. While the near-term direction of the currency is difficult to call given the high levels of policy uncertainty, there is reason for medium-term optimism for those hoping for a stronger CAD. The loonie appears undervalued from a historical and macroeconomic perspective - this undervaluation suggests there is potential for the currency to revert to its fundamental levels over time. Expected rate cuts in other advanced economies may narrow Canada’s interest rate gap, further supporting the currency.
Conclusion: light at the end of the tunnel
While the Canadian economy has faced a difficult period, the Economic Research team highlighted several emerging reasons for optimism. A combination of trade clarity, fiscal stimulus, monetary policy adjustments and a renewed focus on productivity and domestic investment could pave the way for a brighter outlook. As always, much will depend on how policy and economic data evolve, but the message is clear: while the going may be tough now, there is light at the end of the tunnel for Canada’s economy.
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