Monthly Economic Letter

There is still a great deal of uncertainty surrounding the imposition and suspension of tariffs. Tariffs are shaking the global economy and nowhere is that more evident than on either side of the Canada-U.S. border. The evolution of the conflict remains unpredictable, and much can still change.

We currently estimate that tariffs could cause Canadian GDP to shrink by 1% over the course of 2025. Even without tariffs, uncertainty will temper economic gains, holding growth to 1.2% this year, which is below the economy’s potential.  While it's impossible to say with any certainty how deep the economic downturn could be in 2025, it’s clear that trade instability is already having negative impacts.

Impact No. 1: A U.S. economic slowdown

The latest economic estimates are pointing to a decline in U.S. GDP in the first quarter to around -2.4%. An expected increase in private investment (+4.8%) is unlikely to be sufficient to fully offset a slowdown in consumption, which is expected to be neutral (+0.4%). 

The U.S. Federal Reserve continues to face above-target inflation and a tight labour market. The federal funds rate should, therefore, remain in the 4.25-4.50% range when the Fed makes its first 2025 announcement.

Where U.S. GDP growth is really being hurt is in the balance of trade. American companies appear to have brought forward orders from foreign suppliers to build up their tariff-free inventories. (Imports are deducted from GDP.)

Thus, the famous adage that "when the U.S. sneezes, Canada catches a cold" likely won’t apply in the first quarter. Quite the contrary, Canadian merchandise exports are expected to have increased, supporting growth. Following a 6.0% increase in December, total exports rose by 5.5% in January to a record $74.5 billion. Exports account for 19% of Canadian GDP and 77% of the country’s merchandise exports go to the United States.

Impact No. 2: Canadian businesses grow cautious

Faced with uncertainty, companies tend to delay or reduce their investments. They may also adopt cost-cutting strategies, such as freezing hiring or reducing R&D spending. This is expected to be the case for Canadian companies in 2025, given the uncertainty in the business environment. Investment by Canadian companies will be modest, if not negative. 

According to a BDC survey of business leaders conducted in January, many small and medium-sized businesses entered 2025 in a better financial position than in 2024. However, economic uncertainty and concerns about weaker economic conditions in the coming months are prompting many companies to put expansion plans on ice. 

As a result, just 45% of SMEs said they plan to invest in the coming year, compared with 54% in October. This drop in investment intentions affects all three major categories tracked by BDC: non-residential buildings (down 5 points from October), machinery and equipment (down 8 points), and intangible assets (down 6 points). 

Impact No. 3: Consumption, the engine of growth, gears down

When consumers become concerned about an economic slowdown and fear layoffs, they tend to spend less and save more. According to our most recent survey, Canadian consumers say they’re worried about tariff threats and expect to spend less this year.

The decline in consumption is typically felt more acutely in industries linked to consumer discretionary spending and this is likely to be the case in this slowdown too. The sectors that fluctuate more with disruptions in the economy include consumer durables and clothing as well as services such as hotels, leisure activities and restaurants.

What can we expect now

The good news is that the Bank of Canada has leeway to support the economy and hopefully mitigate a slowdown. Inflation has been well under control in Canada for several months now and the key interest rate, at 2.75%, is still in the restrictive zone. Therefore, we can expect the bank to continue easing credit conditions and lower its key rate further over the course of the year, without inflation picking up again.

The desire to reduce trade barriers between provinces and a surge in buy-Canadian patriotism should also help mitigate some of the impact of tariffs. Our data shows that nine out of 10 Canadians plan to act in response to the U.S. tariffs with 63% saying they will buy more local and made-in-Canada products, and almost as many plan to reduce purchases of U.S. products.

Meanwhile, recent weakness of the Canadian dollar against the U.S. greenback has continued with the threat of tariffs. A lower loonie reflects uncertainty as investors continue to shift towards blue-chip assets, including those priced in U.S. dollars. The Canadian dollar should remain between US$0.68 and US$0.70 in the first quarter of 2025. At such levels, the currency supports exports and makes Canadian products and services more competitive with U.S. imports.

What this means for your company

• For entrepreneurs, it will be challenging to navigate an uncertain trade landscape that’s impacting costs and the general economic climate. Business owners need to remain informed and agile, ready to adapt to new trade policies and economic conditions. Above all, now is not the time for panic decisions
• Unstable economic times generally lead to a tightening of bank credit. Entrepreneurs need to be prepared for possible difficulties in obtaining financing and may have to adapt their financial plans accordingly. It’s also important to determine an optimal human resources strategy for the short, medium and long term.
• All businesses will be affected by the trade turbulence, but the severity of the situation will vary according to the duration and severity of tariffs for your industry. Consider strategies to keep your customers engaged and loyal, whether you're in B2C or B2B. You can also capitalize on Canadians’ new patriotism by promoting your home-grown products and services.

The trade dispute with the U.S. didn’t prevent the Canadian economy from starting the year on a positive note, according to Statistics Canada estimates. In 2024, the Canadian economy demonstrated remarkable resilience and the momentum continued in early 2025 despite the turbulence associated with tariff threats and high uncertainty.

An unexpected end to the year

Canada's economy started 2025 on a strong footing after growing at an annualized rate of 2.4% in the fourth quarter of 2024. The third quarter was also revised upwards to 2.2%, a significant improvement on the initial estimate of 1.0%. This performance, which brought GDP growth to 1.5% for the year as a whole, was better than the Bank of Canada had forecast.

Economic activity was boosted by strong consumer spending, the result of the easing of monetary policy. The Bank of Canada’s key rate fell from 5.0% in May to 3.25% in December, a drop of 175 basis points in six months. Household spending and residential investment grew at an annualized rate of 5.6% and 16.7%, respectively, in the fourth quarter.

Business investment, however, remained tepid in the face of economic uncertainty. In the fourth quarter, business investment picked up, but for 2024 as a whole, it was down 1.5% compared with 2023.

According to Statistics Canada, the economy’s year-end momentum continued into January, with growth estimated at 0.3% in January on top of December’s strong performance (+0.2%). Exports were expected to make a positive contribution to GDP at the start of the year because U.S. companies beefed up inventories of Canadian-made goods in advance of the imposition of tariffs.

Despite the strong recent data, it’s important to note that uncertainty remains high and the risks of a slowdown are very real.

A gradual recovery of the residential market should continue

The imminent arrival of spring usually heralds the busy season for the Canadian housing market. Mortgage rates have been on a downward trend since the first interest rate cut was announced last June. The 2024 cuts supported a quick rebound in the resale market. Further rate reductions in 2025 should sustain the recent market momentum, although uncertainty may dampen the outlook.

Concern about the impact of tariffs is high among Canadian households and is likely to lead to greater caution among homeowners and first-time buyers. The reduction in immigration targets announced last autumn could also temper demand for housing.

Residential investment recovered strongly in the last quarter of 2024. However, home sales declined in November and December  before a new wave of listings hit the market in January (+11.0% monthly growth). 

While the increased supply should help rebalance the market, affordability issues persist in the most expensive markets. In fact, price trends vary enormously from one market to the next, both geographically and by type of residence.

Employment in neutral in February

Job creation was virtually non-existent in February, with only 1,100 jobs added. This was a cause for relief in the circumstances since some observers were expecting losses given the uncertainty that’s strongly affecting Canadian businesses. In fact, layoffs in Canada have not climbed significantly to date.

This was a commendable performance for the Canadian labour market in the current context of economic uncertainty. The flat employment picture in February followed the addition of 76,000 jobs in January. The unemployment rate held steady at 6.6% last month, while the labour force (the pool of potential workers) shrank. Wages continued to rise at a rate of 3.8% in February, slightly faster than in January.

The impact on your business

• Businesses across the country will face headwinds as tariff uncertainty builds. Consumers and businesses alike are increasingly cautious for fear of an economic slowdown. Businesses are putting investment projects and hiring plans on hold and consumer spending could become more lacklustre in the months ahead. The good news is that the Canadian economy has continued to show resilience and even regained momentum at the end of 2024. Thus, we enter this period of uncertainty on a solid footing.
• The residential housing market should continue to grow at a good pace in Canada, albeit slower than expected before the trade conflict began. Companies in this sector should do well.
• The Canadian labour market hasn’t been overly affected by the trade conflict so far, which should calm fears of recession. Corporate earnings continue to rise, inflation is well anchored at the Bank of Canada’s 2.0% target, interest rates are falling and savings remain high. Canadian households will be more cautious in their spending but are well positioned to support the economy once the trade situation stabilizes.

Following a challenging year in 2024, the period of high-interest rates is nearing its end as the Bank of Canada moves towards neutral rates, offering significant relief for British Columbia. 

However, B.C. faces new challenges as uncertainty hits record highs. While the province’s consumers will continue to benefit from falling rates, ongoing trade tensions are already causing damage to the economy. 

If tariff threats from the U.S. turn into reality, the impact will depend on their duration and magnitude. B.C. could face a mild recession as a consequence, but not all sectors will be hit the same. Some like tourism and energy would be less impacted than others.

Household debt burdens lighten but confidence dwindles

A solid labour market with decent wage gains softened the blow of high interest rates on consumers last year. 

Nevertheless, households took a cautious stance as they faced signficantly higher mortgage payments and reduced their spending accordingly. 

As inflation fell to around its 2% target, the Bank of Canada cut rates in the second half of 2024. In response, British Columbians boosted their spending and showed signs of increased confidence in the economic outlook. 

However, uncertainty once again took centre stage at the start of this year as the potential impact of trade tensions between Canada and the U.S. came into focus. The turbulence is shaking consumer confidence even before the full impact on the economy has been felt. This could limit household spending growth in 2025. 

Real estate market stuck between two opposing forces

Home sales were stimulated by lower interest rates in the second half of 2024, but heightened uncertainty dampened activity at the beginning of the year.
 
With the outcome of the trade conflict unclear, continued uncertainty will limit residential investment as well as a rebound in home sales. 

Downside risk emerges for B.C., but the province is  less reliant on the U.S.

Trade tensions are dampening business investment intentions, but the export outlook varies among industries. For example, forestry products could be slapped with 25% tarrifs while energy products could be hit by a lower rate of 10%. Gas production is set to advance with new LNG capacity coming into operation around summer benefitting the province. 

Importantly, the province is less reliant on the U.S. than the rest of Canada. About 53% of B.C. exports are shipped to the U.S. versus the Canadian national average of 77%. 

Additionally, an upcoming Chinese economic stimulus package is likely to help buffer B.C.’s indirect exposure to U.S. tariffs on China.  

On a brighter note, the province could attract more tourists from the U.S. who are seeking to take advantage of a lower loonie. As well, more Canadians are choosing to spend their vacation in Canada instead of travelling abroad.  

The impact on your business

• Borrowing costs have fallen. It’s time to assess your financial position and prepare your business for a volatile market.
• Falling interest rates should provide some relief to B.C., which should support better consumption fundamentals.
• Evaluate your productivity and identify quick wins to control costs and increase sales. 
• Study your options for diversifying your sales by taking advantage of Canada’s free trade agreements with the European Union and several Latin American and Asian-Pacific countries.