Despite trade uncertainty due to U.S. tariffs on Canadian imports, the Canadian economy has held up better than we would have expected.  

We expect the Canadian economy to grow by slightly more than 1% in 2025 and 2026. That’s below average, but it’s not a recession. It’s been a struggle, but we’ve seen encouraging signs recently that things are mildly improving. We’re looking for a stronger economy in 2026 than 2025.  

Consumer spending has helped prop up the economy. The “Buy Canadian” campaign has helped, and more people are travelling closer to home. Also, there’s no question that federal government spending has also supported economic growth. 

While the economy has managed to avoid a recession, weakening in the labor market persists. The unemployment rate has steadily crept up over the past year, approaching 7% earlier this year. However, the labor market posted strong job gains in September and October, suggesting that the mood might be lightening a bit among employers.  

We expect the unemployment rate will edge higher in the first part of 2026, perhaps moving above 7%. But as we move into the latter part of the year—boosted by firmer economic growth and lower population growth—we expect the unemployment rate to fall in the second half. 

With the 2026 outlook as the backdrop, let’s dive into the key drivers guiding the economy. 

For the first time in a year and a half, Canada has a federal budget. Its importance lies in the fact that it continues the steps taken throughout the year aimed at strengthening the Canadian economy against the backdrop of trade uncertainty. We’ve seen huge spending in areas like infrastructure, defense and support for businesses that have been affected by the tariffs. That’s the main reason why the budget deficit has gone from an expectation of around $40 billion a year ago to almost $80 billion now. 

As a share of the economy, that deficit will represent about 2.5% of GDP this year. The aim is to reduce to 2% in 2026 as the economy improves. 

Canada’s position in the trade dispute isn’t as bad as it appeared earlier in the year. The average U.S. tariff rate on imports of Canadian goods is between 6% and 7%, compared to the 17% rate the U.S. charges the rest of the world on average. 

The tariffs are also heavily focused on certain targeted industries, such as steel and aluminum, lumber, and auto imports and non-USMCA auto parts. These are important sectors, but they represent a relatively narrow slice of the economy. 

That sense of relief is apparent in how both consumer and business confidence have reacted. In the first half of the year, both indicators were as negative as we’ve seen in the past 20 years. In recent months, however, consumer and business sentiment have improved. They’re still cautious, but not nearly as negative as they were earlier in the year. 

The one silver lining in the weakness in the labor market and overall economic growth is that it’s helped contain inflation. We’re almost back to normal levels after the inflation upturn from 2021 and 2022. We believe inflation will remain close to 2% in 2026 with the bias leaning slightly higher. While lower energy prices have provided some relief, grocery prices and home-related expenses remain thorns in the economy’s side. 

Since June 2024, the Bank of Canada’s overnight interest rate has fallen from 5% to 2.25%. That’s a quick pace of interest rate cuts. The Bank has clearly signaled that they are done cutting interest rates. But if economic growth comes in lower than expected, we still believe there’s a chance the Bank of Canada may decide to trim interest rates once more, especially in light of continuing trade uncertainty, a high unemployment rate and headline inflation remaining close to 2%.  

The bottom line is that while the Canadian economy struggled in 2025, it did manage to avoid a recession even in the face of trade uncertainty. As we go into 2026, we’re looking at a more positive economic backdrop. 

While the Canadian economy in general appears to be stabilizing, the outlook can vary by region. Robert Kavcic, Director and Senior Economist, BMO Capital Markets, offered his insights on the regional economies. Highlights of his remarks follow. 

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  Economic growth is outperforming the national average in 2025. While BMO expects the region to lag slightly behind Canada in 2026, that’s a relatively strong performance considering the Atlantic region’s small economy typically grows at a slower pace than the rest of the country. 

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  Atlantic Canada is relatively sheltered against tariff impacts compared with larger provinces such as Quebec and Ontario. 

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  Residential real estate has been a bright spot. Inventory is clearing quickly, and while housing prices are nearing record highs, the region is still affordable relative to other provinces. 

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  Because industries in the region are highly exposed to tariff impacts, we expect economic growth in Quebec to underperform in 2025 and 2026. 

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  The job market is relatively stable, with the unemployment rate hovering around 1% to 1.5% below the national average, but there are signs that some of the tariff-driven uncertainty is filtering through to manufacturing companies in rural areas. 

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  Residential housing is a plus, with Montreal and Quebec City representing two of the strongest markets in the nation.  

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  If there’s a challenging region in the Canadian economy, it’s Ontario. BMO’s 2026 outlook for the provincial economy is running well below the national average. 

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  The trade dispute and the correction in the real estate market are the most significant challenges. 

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  On a positive note, if certain elements begin to turn in favor of the Canadian economy—such as a trade deal with the U.S before the USMCA comes up for renewal in July 2026—business confidence will recover the fastest in Ontario. 

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  Growth in the region is comfortably above the national average and should remain so through 2026, largely driven by Alberta’s oil-driven economy, which has suffered limited tariff-related impacts. 

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  Housing prices in the region are nearing record highs and mostly avoiding the downward pressure on prices impacting other markets. 

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  BMO expects better-than-average growth in the region through 2026 as it’s sheltered from many of the challenges affecting the national economy. 

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  B.C. has less exposure to U.S. trade than regions such as Ontario and Quebec. 

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  The region is, however, facing the same inflationary factors impacting the national economy, including high food prices, a housing market correction and a soft job market.