Canada’s below-trend GDP growth to continue

Labour markets remain cool as unemployment rate rises

On June 29, Canada withdrew its Digital Services Tax on U.S. firms, followed by the removal of retaliatory tariffs on September 1. These steps reflect a strategic recognition that Canadian exporters face an effective U.S. tariff rate of just 6%, the lowest among major trading partners.

Meanwhile, Prime Minister Mark Carney has announced a series of large-scale nation-building projects under the new Major Projects Office, aimed at accelerating economic growth, strengthening energy security, and modernizing infrastructure. We expect these initiatives will have a more meaningful impact on GDP in 2026 and beyond. Strain on federal revenues stemming from the removal of the Digital Services Tax, a reduction in the lowest marginal personal income tax rate from 15% to 14%, staggered program budget cuts, and the elimination of the consumer carbon tax will constrain the government’s capacity for public spending. These measures, while aimed at easing fiscal pressure on households and businesses, are likely to limit the scope for expansionary fiscal policy in the near term.

The contraction in second-quarter GDP, which fell at an annualized rate of 1.6%, was largely driven by a sharp 27% drop in exports, the steepest quarterly decline since the pandemic. This pullback likely reflects temporary weakness following tariff front-running in Q1 and is expected to reverse in the coming months. Central bankers had anticipated the slowdown, which was compounded by a 10.1% decline in business investment, particularly in equipment and machinery, amid heightened trade policy uncertainty. Meanwhile, consumer spending remained resilient, supported in part by increased discretionary outlays following the removal of the consumer carbon tax, despite stagnant population growth.

Canada’s GDP rose 0.2% in July, marking a rebound after four consecutive monthly declines. Growth was driven by a recovery in oil and gas extraction following wildfire-related disruptions, alongside gains in non-residential building construction (+0.4%) and engineering construction (+0.2%). However, industries directly impacted by tariffs, particularly iron and steel manufacturing, continued to face headwinds.

As shown in Figure 1, we expect GDP growth to remain below trend. For 2025, we maintain our forecast at 1.25%, though the near-term outlook remains highly sensitive to the trajectory of Canada-U.S. trade negotiations.

Slowing population growth, now in its sixth consecutive quarter, combined with strong GDP prints in Q4 2024 and Q1 2025 had temporarily lifted Canada’s GDP per capita, as illustrated in Figure 2. However, that momentum has faded, with GDP contracting by 1.6% in Q2 2025.

Labour markets

Canada’s revised immigration targets are expected to slow population growth by approximately 1.4 million over the next three years, as annual permanent resident admissions decline by roughly 100,000, from 465,000 in 2024 to about 365,000 by 2027. Between January and June 2025, the country admitted 125,903 fewer foreign workers compared to the same period in 2024. The share of non-permanent residents has also declined to 7.3%, down from its peak of 7.6%, contributing to the lowest population growth outside of the pandemic since 1946.

Despite this demographic slowdown, the labour market has not overheated, largely due to the dampening effects of U.S. sectoral tariffs on Canadian goods. Policy uncertainty has led many employers to pause hiring, though widespread layoffs have yet to materialize. The unemployment rate rose to 7.1%, its highest level since May 2016, excluding the pandemic period. Longer job search durations are partly contributing to this rise, with the share of workers unemployed for 27 weeks or more reaching its highest level since 1998, outside of pandemic conditions.

Wage growth, as measured by average hourly earnings, slowed to 3.2% in August, down 10 basis points from July. Canada shed 107,000 jobs across July and August, with losses evenly split between part-time and full-time positions. Labour force participation also declined during those two months, falling from 65.4% to 65.1%, its lowest level since the pandemic signaling a broader cooling in labour market conditions.

In August, job losses were concentrated in trade-related sectors such as transportation, warehousing, and manufacturing, while professional services and education also saw notable declines. In contrast, July’s losses were primarily in culture and recreation and construction.

Youth unemployment remains elevated at 14.6%, a level typically associated with recessionary conditions. This weakness reflects a mix of factors, including higher minimum wages, heightened uncertainty, an increased supply of low-skilled foreign workers, and, though to a lesser extent, automation reducing demand for entry-level roles.

Ashish Dewan CFA, CFP is Senior Investment Strategist at Vanguard Investments Canada. Excerpted from Vanguard’s “Economic Outlook for Canada – Q4 2025”.

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