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Canada enters 2026 on stronger footing than many anticipated, as Canada retains a structural advantage, one of the lowest effective tariff rates among U.S. trading partners, positioning the country to capture greater trade share as supply chains normalize.
Last time we looked at how we expect inflation to moderate as retaliatory tariffs will take time to filter through the economy, falling rents are set to ease shelter inflation, and stalled population growth is likely to temper overall price pressures. With fiscal stimulus supporting growth and employment, the Bank of Canada will have less need to cut rates aggressively to spur activity. This sets the stage for positive GDP growth.
Canada’s economy grew at an annualized pace of 2.6% in the third quarter of 2025, far surpassing expectations of roughly 0.5%. The upside surprise was driven primarily by robust government spending and a marked improvement in the trade balance. Federal expenditures surged, particularly in defense, with spending on military hardware jumping 82%.
However, the headline number masks underlying weakness. Much of the GDP boost came from a sharp drop in imports, which mechanically inflates growth but signals softer domestic demand. Lower imports often reflect reduced consumption and investment, and can disrupt supply chains, hinder production, and erode competitiveness. Indeed, household consumption fell 0.4%, while final domestic demand slipped 0.1%. Business investment continued to decline, and firms pared back inventories amid heightened uncertainty.
The most encouraging development for Canada’s economy is the substantial upward revision of GDP figures for 2023 and 2024, reflecting stronger consumer spending and business investment. These adjustments have lifted productivity estimates and signaled a more resilient growth outlook. As shown in Figure 1, the revised GDP per capita (adjusted estimate) is considerably higher than earlier projections. This revision points to stronger economic momentum and suggests that perceived slack in the economy is much smaller than previously thought.
For 2026, the Bank of Canada’s measured stance, keeping rates near the lower end of neutral, will support credit-sensitive sectors like durable goods and the challenged housing market. Fiscal stimulus announced in the 2025 budget will provide a modest boost while structural reforms, such as reducing interprovincial trade barriers and closing the post GFC US-Canada labor productivity divergence, reinforce Canada’s long-term growth potential.
Canada’s growth outlook will hinge heavily on the outcome of CUSMA negotiations with the U.S. administration. Washington is pressing for expanded access to Canada’s dairy market, the removal of provincial restrictions on U.S. alcohol, and revisions to the Online Streaming Act and Online News Act, which it views as discriminatory toward U.S. digital service providers. Failure to address these demands could result in higher tariffs or the loss of preferential market access, outcomes that would significantly harm Canadian exporters and raise costs for businesses.
Diversifying trade relationships and removing interprovincial barriers remain important goals, but they are long-term projects that will take decades to achieve. This makes a positive outcome in the CUSMA negotiations essential for maintaining Canada’s economic momentum. In the short term, fiscal measures should help cushion the economy, including increased defense spending, expected to reach 5% of GDP by 2035, alongside a middle-class tax cut, elimination of the consumer carbon tax, and government-backed loan guarantees and liquidity support. However, considerable uncertainty persists regarding the execution of government-initiated projects and whether defense spending will deliver spillover benefits to the civilian economy by driving broader innovation and productivity gains.
For 2026, we expect GDP growth to be 1.6% supported by resilient consumption, improving labor conditions, fiscal stimulus, a competitive trade position, and a favorable policy mix.
Canada’s population declined by 76,000 people, marking its first drop outside of the pandemic since 1947 and bringing the total to 41.6 million. The drop was driven almost entirely by a sharp reduction in non-permanent residents (NPRs), which fell by 176,000 in the quarter. This comes on the back of Canada’s revised immigration targets are expected to slow population growth by approximately 1.4 million over the next three years. Businesses are cautioning that labor shortages could weigh on growth, even as the slowdown may bring some relief to housing affordability and ease pressure on an overstretched healthcare system. Slower population growth reduces the need for job creation to maintain the current unemployment rate.
The labor market delivered some good news as the unemployment rate fell sharply from 6.9% to 6.5% in November, marking the largest monthly decline since early 2022. However, for the second consecutive month, most job gains were concentrated in part-time positions, and November saw a 26,000-person drop in labor force participation. It’s worth noting that the Labour Force Survey can be volatile on a month-to-month basis.
Looking at 2025 as a whole, Canada added roughly 325,000 jobs, reflecting a year of uneven but positive growth. The first half of the year was sluggish, with only about 144,000 jobs created by June, but momentum accelerated in the second half. Between September and November alone, 181,000 positions were added, and the final quarter delivered an additional surge of 180,000 jobs.
Job gains were concentrated in health care, social assistance, accommodation, and food services, with additional contributions from manufacturing and natural resources. However, a large portion of late-year growth came from part-time positions, highlighting that while the labor market strengthened, underlying conditions remain uneven. The number of Canadians experiencing long-term unemployment remains elevated compared to 2023, when it began trending upward, though it has recently stabilized. Trade-related sectors were another area of concern. Despite facing significant pressure, strong commodity exports, fiscal support, and adaptive business strategies helped prevent deeper job losses than might have occurred under prolonged trade disruptions.
Figure 2 shows that unemployment declined for both youth and the overall population in November, narrowing the gap between the two. Despite this improvement, 2025 was one of the most challenging years for young Canadians, with unemployment reaching recessionary levels even as the broader labor market remained resilient. While conditions eased slightly toward year-end, structural challenges including skills mismatches, demographic pressures, and sectoral weaknesses continue to pose significant headwinds.
We anticipate the labor market will gradually strengthen as uncertainty recedes, slower immigration tempers population growth, and steady consumption supports solid real wage gains. By year-end, we expect the unemployment rate to decline to approximately 6.2%.
Ashish Dewan CFA, CFP is Senior Investment Strategist at Vanguard Investments Canada. Excerpted from Vanguard’s “Canada 2026 Outlook.”
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