Key Takeaways:Canada’s economic weakness could persist for the remainder of the year.Analysts see a resurgence in the next year as trade uncertainty abates and growth picks up.The Canadian dollar is poised for a stronger finish against the US dollar.Low interest rates will keep the bond markets humming for the foreseeable future.
After three tumultuous quarters in which the Canadian economy has faced steep US tariffs, fears of recession, labor market contraction and stalled GDP, Canada finally enters the final-quarter of the year bruised, but with a growing consensus among economists that Canada will avoid a hard recession.
While not much is likely to change in the short-term, with analysts expecting the economic pain to persist for the remainder of the year, some do see potential for an uptick in 2026.
Before then though, tariffs, mounting unemployment and sagging productivity could further stifle business investment and consumption, and continue to be a drag on the domestic economy in the fourth quarter, economists warn.
“Domestic activity was strong in the second quarter, but we don’t expect that strength to continue into year-end,” says Tiago Figueiredo, macro strategist at Desjardins. “Slowing population growth and ongoing mortgage renewals should continue to keep economic activity relatively muted.”
He acknowledges, though, that the economy is likely getting some boost from past rate cuts. Still, “the recent rise in global long-term interest rates is dampening some of the impact from [those] cuts,” he adds.
Economy to End the Year With a Whimper
Supportive Bank of Canada monetary policy notwithstanding, analysts still anticipate sufficient headwinds to support their less-than-cheery year-end outlook for the Canadian economy.
“I expect further slowing in growth in the second-half, GDP averaging around flat, and, importantly, with the slowdown in activity not just concentrated in trade-exposed sectors but broadening to the rest of the economy such as various services,” cautions Citi economist Veronica Clark.
Recent labor market data for the second half of the year has already shown more deceleration in job growth coming from these sectors, she adds.
Dawn Desjardins, chief economist at Deloitte Canada expects consumer spending, which has remained resilient thus far, to begin to wilt in the fourth quarter.
“We are wary that the softening in the labor market and low confidence will result in weaker than usual spending for the remainder of this year,” she says in a recent report.
Capping immigration “resulted in negligible population growth in the second quarter and this trend will continue in 2026 given the government’s downsizing of its targets,” she says The result of which could be a double whammy – of crimped consumption and a deteriorating labor market.
“With both employment and the labor force softening, the unemployment rate, which hit a recent high of 7.1% in August, is unlikely to move much higher, [but] labor market conditions will remain strained in the near-term,” she warns.
Against that backdrop, Deloitte’s Desjardins forecasts real GDP to gain 1.3% this year and 1.7% next year.
A Rebound on The Horizon
Despite a grim forecast for the near-term, some observers expect things to start looking up in 2026.
Deloitte’s Desjardins says the groundwork is laid for better prospects in 2026.
“The Bank of Canada is expected to provide some additional stimulus to boost consumer and business confidence,” she says.
Although sector-specific tariffs will continue to impact manufacturing industries, Canada is facing low overall average tariffs, compared to other countries, which “is minimizing the size of the economic damage,” she says.
The outlook for a pickup in growth next year is also underpinned by the prospect of increased “clarity on the fiscal front, monetary stimulus and the expectation that the trade sector adjustments will largely be behind us,” Desjardins says.
Meanwhile, Desjardins’ Tiago Figueiredo expects the Canadian economy to undergo some notable structural changes in 2026. “With globalization under pressure, economic growth is set to be more concentrated in the domestic economy,” he says.
A key factor that could drive Canada’s medium-term growth is the Carney government making good on its promise of increased defense and infrastructure spending.
“We’re past the point of bold declarations,” says Figueiredo, adding that “what will matter going forward is the nitty-gritty of executing on these projects.”
Most of the pickup in the “[economic] activity we’ve penciled into 2026 is driven by public investments,” he adds.
Citi’s Clark strikes a contrarian note though in expecting Canada’s economic woes to persist.
“I think the slowing in demand will be with us into 2026,” she says, stressing that the “output gap is already widening further with the unemployment rate rising.”
Bright Prospects for the Bond Market
The fourth-quarter is expected to be a solid quarter for Canadian fixed income. With growth softening and inflation pressures receding, the odds are high that the Bank of Canada continues its rate-cutting cycle.
“Lower and declining inflation and lower and declining [economic] growth are both very positive for government bonds,” says Konstantin Boehmer, head of fixed income and portfolio manager at Mackenzie Investments.
“Absent a truly game-changing federal budget, which we do not expect, the disinflation and weak-growth trend should persist, supporting bonds.”
A game changing budget, he says, would comprise ingredients that increase Canada’s economic strength.
These could include functional transportation for people and goods, reliable and affordable grid and energy systems, faster approvals of productive projects, substantial investments in schools and trade skills, digital infrastructure that is modern and secure, collectively driving private capital to follow.
Boehmer also points to the divergence between US and Canada monetary policies, which has led to “Canadian bonds outperforming US bonds, especially those under 10 years of maturity.”
He sees attractive opportunities for bond investors beyond the fourth-quarter, through 2026. “We’re constructive on high-quality bonds in Canada, particularly government bonds in the front end and belly of the curve [out to about 10 years],” he says.
Long-dated US inflation-linked bonds are also “interesting investments,” he notes.
Further afield, Boehmer is particularly optimistic about opportunities in “local-currency emerging markets, especially Mexico, Brazil, and South Africa, where real yields and policy credibility remain appealing.”
The Canadian Dollar Claws Higher
Nick Rees, head of macro research, Monex Canada, forecasts the Canadian dollar will end the year stronger against the US dollar.
His outlook is underpinned by the expectation that the Bank of Canada holds the rate in October, while the US Federal Reserve cuts rates at both of its two remaining meetings this year.
“We see growing risks that the Fed will cut rates too far, based on the FOMC’s recent decisions, though this poses upside risks for USD/CAD both via a weaker greenback and through positive growth spillovers,” he explains.
He also points to uncertainties arising from the ongoing US government shutdown and the upcoming Canadian federal budget in November. However, Rees assures, “on balance, we think both tilt risks in favor of [the Canadian dollar with] year-end USD/CAD call of C$1.36,” from the current C$1.40, as of Oct. 22.
Even though its upside story continues past the fourth quarter, Rees projects the Canadian dollar will “underwhelm against the broader G10 complex.”
This is because the Canadian economy remains too tightly bound to the US, “where we expect to see growing signs of slowdown, for the loonie to make outsized gains,” Rees adds.
The other major risk looming on the horizon is the review of USMCA, the continental free trade agreement, due next July. “Given the recent approach of the Trump administration to such negotiations, we suspect this will likely prove a headwind for the loonie, once the process kicks off in earnest,” Rees cautions.
Bank of Canada Policy Predictions
Analysts expect the Bank of Canada to continue to cut rates in the fourth quarter, and likely in 2026, to stimulate growth, provided inflation remains in check.
“Monetary policy remains the immediate and flexible lever to stabilize growth,” says Desjardins’ Figueiredo, who forecasts the central bank to lower the policy rate to a trough of 2.00%.
The timing of that easing, though, will be conditional on “continued progress on core inflation measures,” he says, but adds that “we don’t believe that there is an inflation problem in Canada.”
Citi’s Clark says policymakers will still primarily be concerned about inflation and be cautious of turning too dovish. She forecasts “a cut in October” and a policy shift indicating more cuts to follow.
“Eventually, policy rates falling below neutral will help boost demand again, as well as more fiscal support into 2026,” she says.
Boehmer forecasts two additional cuts in 2025 but says “the Bank of Canada is likely uncomfortable taking the policy rate to 2.00%, particularly if the US Federal Reserve delivers only one more cut in 2025, which is our base case.”
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