Key takeaways:
- Canada’s first six months of 2025 were marked by a trade conflict with the US and extreme uncertainty. This led to weaker economic activity, with a likely contraction in Q2 and a higher unemployment rate, while persistent inflationary pressures have led the Bank of Canada to cut its policy rate by less than expected.
- As we begin the second half of 2025 and examine how the economy evolves, we note that the level of US tariffs on Canada is much lower than initially feared when President Trump originally announced tariffs on Canada.
- As a result, the direct impact of tariffs on Canada has been smaller than feared and the negative consequences are mostly the result of the surge in uncertainty and plummeting business and consumer confidence.
- As uncertainty started to fade in recent months, business and consumer confidence has improved somewhat but remains low. This situation suggests that the economy is no longer deteriorating and that, barring a negative shock such as an escalation on the tariff front, the worst is likely behind us.
- The Canadian economy has likely avoided a recession. However, we shouldn’t expect a sharp rebound in economic activity in the second half of 2025, as continued high uncertainty weighs on the economy.
- The BoC is currently more concerned with its preferred measures exceeding 3% than with the increasing amount of slack in the economy. Moreover, the breadth of inflationary pressures (i.e. the share of CPI components growing more than 3%) is above historical norms and at a level inconsistent with inflation at 2%.
- With trade uncertainty abating and the economy no longer deteriorating, pressures on the BoC to cut rates are reduced. However, as we have shown (see Searching for the terminal rate), the sharp deceleration in population growth will lower the neutral rate over the next 2 years.
- We believe that the BoC is likely to cut once more this year, bringing the policy rate to 2.50%. The timing of this cut is likely to be sooner rather than later and will only occur once core inflation falls below 3%. Because of the composition of Alberta’s exports, the effective tariff rate on Alberta is likely lower than for the rest of the country. Hence, the direct impact of US tariffs is smaller on the province’s economy, with confidence shock and lower energy prices being the main drag on growth so far this year.
- We expect the Alberta economy to outperform the rest of the country in 2025, supported by robust population growth, continued rise in energy production, and strong residential investment.
To say that the first half of 2025 was eventful would be an understatement. The first six months of the year were marked by a trade conflict with our main trading partner and extreme uncertainty. The result has been a weaker than expected economy; economic activity likely declined in the second quarter, the unemployment rate is higher than projected and the housing market weakened. On the flip side, persistent inflationary pressures have meant that the Bank of Canada has cut its policy slightly less than anticipated and interest rates have declined as much as expected.
As we begin the second half of 2025, we examine how economic conditions are expected to evolve.
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| Fig 1. Economic policy uncertainty index – Canada |
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| Source: Baker, Bloom, Davis via Bloomberg |
US Tariffs: The situation is better than initially feared.
The initial announcement by President Trump stated an intention to impose tariffs of 25% on all US imports from Canada, except energy imports, which would be tariffed at 10%. However, as time progressed, many changes were made and carveouts were implemented: tariffs of 10% on potash, no tariffs on USMCA-compliant exports, etc.
As a result, US tariffs are currently as follows:
1. 25% tariffs on all imports that don’t comply with the Canada-United States-Mexico Agreement (CUSMA).
2. 10% tariffs on non-CUSMA-compliant imports such as potash and energy products.
3. 50% tariffs on aluminum and steel imports.
4. 25% tariffs on all cars and trucks not built in the U.S., with the 25% only applying to non-US contents of the final product.
It is clear that the extent of tariffs, while bigger than they were at the end of 2024, is not as dramatic as initially feared when President Trump announced tariffs on imports from Canada in early February. In fact, it is estimated that the current effective tariff rate on US imports from Canada is 2.285%; this is 10 times smaller than the effective tariff rate of 20.3% initially announced at the beginning of the year (i.e. 25% of all Canadian imports, except for 10% on energy).
The impact of tariffs on the Canadian economy was tramsmitted via three channels:
1. The direct impact on affected industries, especially the manufacturing sector, is a decline in exports to the US, resulting in lower economic activity and job losses in those sectors.
2. The inventory buildup in anticipation of the disruption brought forward some spending by businesses and consumers. This led to short-term volatility in Canadian external trade, with a strong increase in exports and imports in Q1, which was followed by a sharp decline in Q2; this likely exacerbated the direct reduction in exports due to tariffs.
3. The elevated level of uncertainty pushed businesses to delay, postpone or cancel some spending and to freeze hiring. On the consumer side, restrained spending reduced growth in Canada.
However, with the level of tariffs being relatively low, their impact should be relatively modest and temporary, especially if they stay at current levels.
| Fig 2. CFIB Business Confidence | Fig 3. Conference Board consumer confidence index | |
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| Source: CFIB, Alberta Central | Source: Conference Board of Canada, Alberta Central |
Extreme uncertainty is fading but will remain elevated.
The level of economic policy uncertainty skyrocketed at the beginning of the year, according to the Economic Policy Uncertainty index, reaching a record high in March. The sharp increase was not only the result of uncertainty generated by the trade war with the US, with many political developments in Canada – PM Trudeau’s resignation, a Liberal leadership contest, and a federal election – exacerbating uncertainty.
With the political situation in Canada now more stable following the election of a Liberal government and an easing in the threats to Canada from President Trump – whether it is tariffs or discussion of making Canada the 51st state – uncertainty has eased significantly in recent months.
As the extreme uncertainty fades away, there’s been an improvement in economic confidence, with both business and consumer confidence indexes bottoming out in recent months.
While further reduction in uncertainty should be expected, barring a breakdown of talks between Canada and the US, it is likely to remain elevated until a new trade agreement is signed between the two countries. Hence, business and consumer confidence are expected to continue to improve but could remain weak for some time.
Nevertheless, fading uncertainty is leading to a bottoming out of confidence indexes, suggesting that the economy is no longer deteriorating. In other words, barring a negative shock, such as an escalation on the tariff front, it is likely that the worst is behind us.
This means that the Canadian economy has likely avoided a recession. After a decline in economic activity in Q2, we should expect growth to return into positive territory in Q3. However, this doesn’t mean we should expect a sharp rebound in economic activity in the second half of 2025, as continued high uncertainty will continue to weigh on the economy.
With improved consumer confidence, we anticipate that consumer spending and the housing market will improve in the second half of the year. However, with growth remaining modest, the labour market is expected to remain weak, and the unemployment rate is expected to drift higher. However, this would be mainly the result of weak job creation rather than job losses; this is suggested by the hiring intentions according to the Canadian Federation of Independent Businesses, which indicates that net hiring intentions are no longer in negative territory. Similarly, improved business sentiment should see businesses restart some investment projects that were frozen due to elevated uncertainty.
Nevertheless, the continued expected slowdown in population growth, as the federal government continues to restrict the number of temporary residents in the country, will remain a drag on the economy. However, an improvement in consumer spending per capita could offset some of the drag from slower population growth.
Inflation
Inflation has been affected by the GST holiday at the turn of the year and the removal of the Carbon Tax in April; it is currently at 1.7%, slightly below the midpoint of the inflation target.
However, the BoC’s preferred measures of core inflation have remained elevated and have been above 3% since April, and their momentum, as measured by the 3m/3m annualized change in the core indexes, has been above 3% in seven of the last 8 months, suggesting some stickiness. However, alternative measures of core inflation, such as CPI excluding food and energy or CPI excluding the 8 most volatile components, have remained below 3%.
The details of what has been driving inflation show that, while lower shelter and energy costs are holding back inflation, many CPI components have seen an acceleration; these drivers are led by communication, clothing, travel services, and food. As such, the breadth of inflation, as measured by the share of CPI components that are increasing by more than 3%, bottomed out in December and is reaching 37%. This is well above historical norms and where it usually sits when inflation is at 2%.
Some of the upside pressures on prices in recent months are likely the result of the following:
- counter tariffs Canada imposed on select US imports;
- elevated uncertainty and US tariffs being passed to consumers, and;
- continued pass-through from the weak Canadian dollar earlier this year.
With the amount of slack in the economy expected to increase as growth continues to remain weak, inflationary pressures should ease in the second half of the year. As a result, the BoC’s preferred measures of inflation are expected to decline below 3% in the coming months, but they should remain in the upper half of the inflation target for the rest of this year and the next.
| Fig 4. Momentum in core inflation | Fig 5. Breadth of inflationary pressures | |
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| Source: Statistics Canada, Alberta Central | Source: Statistics Canada, Alberta Central calculations |
Monetary policy
The Bank of Canada has cut its policy rate twice so far this year. However, it is clear that the current concern is more about the high level of core inflation, which has been at or above 3% over the past two months, the strong momentum, and the breadth of inflationary pressures, rather than increasing slack in the economy.
With trade uncertainty abating and the economy no longer deteriorating, pressures on the BoC to cut rates are reduced.
Nevertheless, further cuts are likely. As we have shown (see Searching for the terminal rate), the sharp slowdown in population growth will push potential growth lower. As a result, the neutral rate could end up being lower than the BoC estimate. This means that the current 2.75% could be restrictive unless we see a pickup in productivity, offsetting some of the negative impact of population growth on potential growth.
With all this in mind, we believe that the BoC is likely to cut one last time this year, bringing the policy rate to 2.50%. The timing of this cut is likely sooner rather than later and will only happen once core inflation falls below 3%. This could be as soon as at the July meeting but is likely to be delayed to September.
The longer end of the yield curve is being influenced by US rates, with concerns regarding the US fiscal situation and a resilient economy keeping US rates higher. This means that longer interest rates are unlikely to ease much further as the BoC cuts interest rates again.
Alberta’s Economy
Because of the composition of Alberta’s exports, which is more energy and agriculture-focused than manufacturing-focused compared to the rest of the country, the effective tariff rate on Alberta is likely lower than for the rest of the country.
Hence, the impact on the Alberta economy has mainly been affected through the decline in confidence and the drop in energy prices. Surprisingly, however, the labour market in the province has underperformed compared to the rest of the country, with approximately 9,000 job losses since the beginning of the year.
Nevertheless, we anticipate that the Alberta economy will grow at a faster rate than the rest of the country in 2025.
Robust population growth, albeit at a slower pace than in recent years, will continue to be a strong tailwind to the economy. Population growth is expected to remain higher than the rest of the country, supported by a continued solid influx of migrants from other provinces in search for better affordability.
Housing construction activity is robust and much stronger than in the rest of the country, with housing starts reaching an all-time high in May 2025. Similarly, continued increase in energy production, helped by the increase in exports capacity provided by TMX and LNG Canada, will also be a support for growth.
Consumer spending in the province has been held back by multiple years of wage growth underperformance and a declining purchasing power, as wages in Alberta converge to the national average. This wage underperformance has meant that spending per capita has been much weaker in the province than in the rest of the country. However, strong population growth meant that aggregate consumer spending remains a strong source of growth.
| Fig 6. Forecast table – Canada |
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| Source: Statistics Canada, Bloomberg, Bank of Canada, Alberta Central |
| Fig 7. Forecast table – Alberta
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| Source: Statistics Canada, Bloomberg, Bank of Canada, Alberta Central |