Monthly Economic Letter

As we look ahead to 2025, Canadian entrepreneurs face a varied economic landscape. Despite potential headwinds, there are many reasons for cautious optimism.

The key economic challenges of the last two years are improving.

• Inflation is expected to stay within the Bank of Canada’s target range of around 2% next year. 
• Given the positive inflation picture, interest rates should continue to come down.

Overall, the economy is still on track for a soft landing: a recession appears to have been avoided and the economy looks ready to return to moderate growth.

Interest rates will be the deciding factor in the year ahead

Just as it took time for interest rate hikes to tame inflation and work their way through the economy, the build-up of momentum from rate cuts will also be gradual. Back in March 2022, the Bank of Canada’s policy rate stood at 0.25%—the starting point for the rapid cycle of monetary tightening that followed. In 2024, the bank made a U-turn. From a peak of 5.0%, it lowered the policy rate to the current 3.25%.

That was good news for Canadians and there are more rate cuts to come. We expect the bulk of the remaining reductions to be made in the first half of 2025. BDC forecasts the Bank of Canada’s policy rate to reach 2.75% by mid-2025 and may even close 2025 at 2.5%.

That will help the Canadian economy to grow modestly in 2025, with GDP growth projected to come in at 1.5% for the year. Thus, the economy should continue to expand, albeit at below its potential for a third year in a row. 

Stronger consumer spending and a rebound in residential investment will lead the way next year. Lower rates should translate into cheaper borrowing costs for most kinds of loans while, on average, pay cheques should rise faster than prices. While many consumers still say they plan to reduce their spending in response to elevated interest rates and/or the expectation of high inflation, the trend is positive. 

The unemployment rate ticked higher through 2024 and private employment gains stalled at the end of the year. With a high level of uncertainty in the economy, businesses are more likely to maintain their current workforce rather than increase it substantially. 

On the other hand, a slowdown in immigration, coupled with the ongoing retirement of baby boomers, should give employment a boost next year, providing more support for GDP growth and consumption.

Challenges remain

Despite the brighter path ahead, the Canadian economy is not out of the woods yet.

1. Even with lower interest rates and inflation back to target, households continue to struggle with heavy debt burdens. Interest-only payments now account for almost two-thirds of all debt reimbursements. Therefore, the impact of elevated interest rates will continue to restrain household spending even when rates have come back to a neutral level of between 3.25% and 2.25%. 

On the inflation front, a return to target doesn’t mean prices will come down. It just means increases have moderated to a more sustainable pace. We see little risk that inflation will take off again. However, the housing market is one potential source of inflation. As rates fall, home buying tends to pick up quickly. A recovery in certain cities is already building steam and this could keep shelter inflation high. Inflation in rented accommodation stood at 7.1% in October and owned accommodation at 5.0%.

2. Reduced immigration targets are another factor that could undermine growth in 2025. The government has announced a drop in the number of new permanent residents and temporary residents over the next two years. This will translate into a population decrease of 0.2% in 2025 and again in 2026.

As a result, we estimated the population aged 15-64 is set to fall by more than 450,000 between the end of 2024 and the end of 2026. By contrast, the international immigration and net non-permanent residents from this age group grew by over 1 million in 2024 (that’s roughly the entire population of Nova Scotia).

Population increases were central to the resiliency of the Canadian economy in recent years. In fact, they were probably the key reason we were able to avoid a recession. 

For business owners, a growing population has meant more consumers and a larger pool of potential workers. A decrease in the population could therefore keep a lid on growth, especially given Canada’s aging population and the different consumption patterns that come with it. 

3. Finally, the big cloud hanging over the Canadian economy in 2025 is Trump 2.0. The President-elect talks a lot and seems to have a busy agenda for dealing with the U.S.’s main trading partners, including Canada. However, there’s a difference between talk and action. The main issue for Canada is the spectre of trade tariffs. On the campaign trail, Trump promised to impose a blanket 10% tariff on all imports into the U.S., except those from China, which would be hit with a 60% tariff.  A week after his election, he revised those numbers to 10% on Chinese goods and 25% for those from Canada and Mexico.

Of course, we have to take seriously the threat of U.S. tariffs and the impact they would have on the Canadian economy. However, given the integration of the two economies, we are skeptical that Canada will be subject to a long-lasting blanket tariff on our exports to the U.S.

For now, the only certainty about the arrival of the new U.S. administration is that it’s bringing more uncertainty.  Uncertainty tends to hurt growth—businesses may decide to ramp up inventories ahead of tariff announcements or postpone investments. Being able to forecast demand with a certain level of accuracy is key to inventory management and business optimization.

Trump administration policies could also make the Canadian dollar fall even further against the greenback. The loonie could slide closer to US$0.70 in early 2025, depending on which policies the new U.S. administration promotes. A further drop in our exchange rate would hurt the purchasing power of Canadian households and businesses for foreign goods and services. 

A strong U.S. dollar would also take a toll on Canadian exports to elsewhere in the world by hurting demand for commodities and other goods traded on international markets in U.S. dollars.

A silver lining

It's not the first time the Canadian economy has faced such headwinds. Despite these challenges, Canadian companies have shown resilience in the past and we believe they will do so again in the months and years to come. 

The key is to keep a close eye on emerging trends impacting your businesses and act on them. One way every business can build resilience is by focusing on improving their productivity. By strengthening your innovation, technology adoption and operational efficiency, you will be in a better position to navigate the complexities of 2025 and beyond.

 Keep abreast of key economic indicators.

Canada’s economic growth slowed to an annualized pace of 1.0% in the third quarter, lower than the solid 2.0%-2.2% annualized quarterly growth rates in the first and second quarters of the year. 

For the first nine months, GDP rose by 1.3% compared with the same period in 2023. Statistics Canada’s initial estimate for October points to further softening with GDP likely having stagnated.

Households finances and spending are improving, but businesses remain cautious

In the third quarter, households were able to continue spending and keep their savings rate elevated thanks to a strong increase in disposable income, which was up 9.4% in the quarter. 

The recent drop in interest rates encouraged a pickup in consumer spending, led by purchases of new trucks, vans and sport utility vehicles as well as durable goods that are typically purchased with financing. Interest payments on mortgages and consumer credit declined for the first time in three years, giving more room for households to spend elsewhere.

Entrepreneurs didn’t share consumers’ renewed enthusiasm for spending. Business investment on machinery and equipment slowed markedly and inventories were also a drag on growth in the third quarter. Investment on non-residential structures and equipment plummeted by 11.3% in Q3, primarily because of a significant decline in aircraft investment. This reversed a surge in the second quarter when investment on non-residential structures and equipment jumped by 14%.

Inflation continues to be well controlled

Even as consumption increased, overcapacity in the economy kept inflation in check. Consumer prices rose 2.0 % in October compared to the same month last year. 

The rise was driven mainly by higher shelter costs (+5.0%). Inflation excluding mortgage interest costs stood at 1.4% and has remained within the Bank of Canada’s target range for over a year now.  While the bank’s measures of core CPI moved higher—by an average of 2.6%—this inflation uptick is not worrisome. 

The Bank of Canada’s fight against inflation is largely over and governors are probably now keeping a closer eye on the health of the economy and the labour market. That’s why the bank is likely to announce an additional 50-basis-point cut at its December’s meeting and continue on this course during the first half of 2025.

More slack in the labour market 

Total employment has risen sharply in November, thanks to the public sector, which will therefore support growth. The Canadian economy created little over 50,000 jobs that month. . Labour supply continued to increase faster than the number of jobs being created with nearly 140,000 additional potential workers coming into the market. At 6.8%, the unemployment rate in November was among the highest levels the country has experienced since COVID.

Unsurprisingly, the pace of job creation continued to stall in the private sector. Giving the high level of uncertainty and ongoing slowdown, many companies have put hiring on hold. In September, jobs available in Canada decreased by 18% compared to a year ago. For the past year, the number of companies reporting labour shortage has been consistently below its historical norm. 

The impact on your business

• Despite the economic slowdown, household spending is rising, driven by higher disposable incomes and lower interest rates. This could present opportunities for businesses targeting consumers, especially those offering durable goods where renewed demand seems to be emerging.
• Inflation remains moderate. Entrepreneurs should continue to monitor inflation trends as they can affect cost management and pricing strategies.
• Business investment is lagging, particularly in machinery, equipment and non-residential structures. The Bank of Canada has cut interest rates and is expected to continue to do so next year. Entrepreneurs should therefore start thinking about their next investments, given lower rates and the growing need for Canadian businesses to improve their productivity and boost competitiveness.

As Canada heads into 2025, economic growth is set to pick up from coast to coast. GDP is expected to rise to 1.5% in 2025 from 1.0% in 2024 as lower interest rates from the Bank of Canada pave the way to a brighter economic landscape. 
The bank decides monetary policy on a national level, but Canada’s economy varies from one region to another. Some provinces are more sensitive to interest rates, either because their population is more indebted or because a greater share of their GDP comes from sectors where consumers use financing to make purchases, such as real estate or automobile manufacturing. However, recent declines in interest rates, which should continue in 2025, are creating an upswing in all provinces. 

Resource-oriented provinces should continue to outperform the national average in 2025. The global economy is forecast to grow at a robust pace in the coming year as inflation declines and credit conditions ease worldwide.
While these factors will be counterbalanced by heightened trade uncertainty and geopolitical conflict, a drop in the Canadian dollar versus the U.S. greenback will make commodity producers more competitive and help boost exports. 

Provinces with closer ties to U.S. are facing greater uncertainty over possible tariffs from the new Trump administration. But they will also benefit more from a lower Canadian dollar and solid growth expected south of the border. 

Just as rising interest rates dampened the residential housing market and construction sector first and foremost, the opposite will be true as rates fall. More favourable credit conditions should encourage growth in the real estate market even if a decline in population growth rate tempers the net effect.

British Columbia

High interest rates added to the already heavy debt loads many British Columbians were carrying thanks to expensive home prices. Now, rate cuts are bringing some relief for households and should stimulate spending and residential investment. The weaker Canadian dollar should also stimulate tourism in the Rockies and elsewhere in the province.

Growth drivers: consumer spending, residential investment, tourism.

Alberta

The economy should continue to benefit in the new year from a strong labour market, still robust population growth and higher exports. Even with lower oil prices this year, crude production will be supported by the ramp-up of volumes in the TMX pipeline and strong demand from U.S. refineries.

Growth drivers: residential investment, energy exports, strong labour market.

Saskatchewan

Employment held up strongly in 2024, which supported residential investment and household spending. With the financial situation of Canadian households improving, Saskatchewan should see the benefits in the coming months. While the province’s key resource industries are always prone to volatility, non-residential investment will be supported by the giant Jansen potash project, which will give a boost to the construction sector and the overall economy in 2025. 

Growth drivers: commodities exports, strong labour market, non-residential construction.

Manitoba

With one of the most diversified economies in the country, Manitoba has enjoyed steadier GDP growth than other provinces with employment and household spending faring relatively well in recent years. With Canada set to experience a widespread economic recovery, Manitoba will benefit from spillover effects since 50% of its exports are interprovincial. Manufacturing shipments have already benefitted from interest rates cuts.

Growth drivers: interprovincial exports, manufacturing, consumer spending.

Ontario

The economy will improve in 2025, driven by investments in the auto sector and renewed growth in manufacturing. As far as internal demand goes, many highly indebted households will have to renew their already elevated mortgages at higher rates. The residential housing market will be an important driver of growth even if we don’t expect it to return to its peak level over the coming year. Lower home prices are still in store for some local markets, notably in the GTA condominium market. Nonetheless, the province is expected to fare better as the Bank of Canada’s rate cuts work their way through the economy.

Growth drivers: residential investment, consumer spending, rebound in manufacturing and non-residential construction, strong U.S. demand.

Quebec

Quebec’s economy started to recover in 2024 even though it didn’t benefit from the same boost from migration that other provinces did. In 2025, lower interest rates will help stimulate construction in the residential sector where new housing starts already increased by 18% this year and should continue on that upward trend. An aging population and low immigration targets will create competition in the labour market as economy recovers. The province should therefore benefits of a still robust labour market.

Growth drivers: residential investment, consumer spending, strong labour market.

New Brunswick

With refined oil and manufactured goods as its main exports, New Brunswick will be keeping a close eye on trade developments south of the border. Uncertainty over U.S. trade policy could affect New Brunswick’s economy more than other provinces since over 90% of its exports go to the U.S. On the bright side, the fundamentals for stronger consumption remain in place. The province will benefit from its lower indebtedness level and strong employment will strengthen consumer spending.  The provincial government also enjoyed a strong balance sheet that could support public spending and investment.

Growth drivers: Consumer spending, strong labour market, strong U.S. demand.

Nova Scotia

The economy remains solid even as a population boom in recent years moderates. Interprovincial migration has been a strong contributor to the population increase in Nova Scotia and this will help limit the impact of federal immigration reductions compared to other provinces in the Atlantic region. Stronger auto parts and food shipments should support growth in 2025.

Growth drivers: Consumer spending, residential investment, robust exports.

Prince Edward Island

A growing population has been a key factor in the province’s robust economic performance in recent years. Even with lower national immigration targets, P.E.I. should continue to enjoy strong momentum fueled by newcomers.

Growth drivers: Consumer spending, residential investment, robust exports.

Newfoundland and Labrador

Renewed offshore oil production will lead to strong positive GDP growth. The labour market has shown signs of improvement, which is supportive of a rebound in household spending.

Growth drivers: energy exports, non-residential investment.