Economic Outlook: Safeguarding a Vital Relationship and Investing in a More Productive Economy

The Canadian economy is confronting high global uncertainty and risk. A new U.S. administration will reshape economic policy and international relations in a period already characterized by a fragmentation of global trade and supply chains. President-elect Trump’s threat to impose a 25% across-the-board tariff on all goods from Canada and Mexico upon taking office is a first dramatic manifestation of what may be a disruptive period for international economic diplomacy.

Canada is entering this new period with a solid capacity to contribute to a more secure and more competitive North American economy, but also with domestic vulnerabilities, including a trend of low productivity growth.

An immediate imperative is to work with the incoming Trump administration to safeguard the vital Canada–United States relationship. The medium-to long-term game is to invest in a more productive economy. Our national interest dictates advancing both priorities together.

Moderate Global Growth and Elevated Uncertainty and Risk

The International Monetary Fund’s (IMF) latest World Economic Outlook (WEO), released in October, projected that real GDP globally would grow by just above 3% in both 2024 and 2025, with inflation falling and returning to target in most developed economies.

While the analysis enabled the IMF to state that “the global battle against inflation has largely been won” and that this had been achieved without a global recession, much of the focus of the WEO turned to the risks, described as largely tilted to the downside amid policy uncertainty.

This backdrop of modest growth and lower inflation, with declining interest rates and with elevated global risks and uncertainty, underpins this Bennett Jones 2025 Economic Outlook.

Constructing an Adjusted Scenario for the United States and Canada for 2025 and 2026

The new U.S. administration will take office in a period already characterized by global stress arising notably from wars in Ukraine and the Middle East, and from rising strategic and economic tension in the United States–China relationship.

Globalization is not in full retreat. Global trade is growing at more or less the same rate as global output. But there is a measure of United States–China decoupling and a restructuring of supply chains such that trade is rising faster within, than between, geopolitical blocs. Moreover, after decades of trade liberalization, trade and industrial policies globally are increasingly protectionist.

Looking to 2025 and 2026, China, the European Union (EU), Japan and other developed and developing economies all face material economic, financial and geopolitical risks that cloud their short-term prospects.

Our focus is the economic outlook for the United States and Canada in 2025 and 2026, and how it may be affected by policy developments.

Front and center is the agenda of the Trump administration, including tariffs, tax cuts, deregulation and the massive deportation of illegal immigrants, and how it may impact real output growth, inflation and interest rates.

To construct a scenario for the United States and Canada that adjusts for recent policy developments, we assume that President Trump will not apply, at least immediately, a 25% tariff on all imports from Canada and Mexico; however, we consider the impact of the threat of tariffs and the resulting uncertainty.

The Outlook for the United States

Early in the mandate of the new administration, the promise and implementation of tax cuts and deregulation will support confidence, investment and spending, and this will be only partly offset by the potential impacts of tariffs, even if introduced broadly during 2025.

Some momentum may carry through 2025, and possibly into 2026; however, since the U.S. economy is already operating roughly at capacity, the higher level of activity will put upward pressure on costs. Higher inflation, exacerbated by tariffs if imposed, together with a widening fiscal deficit will keep interest rates higher and eventually this will depress domestic demand. A stronger U.S. dollar will weaken competitiveness, and a large current account deficit will widen further.

In net terms, we estimate that the impact of the Trump economic agenda on U.S. economic growth will be positive but small in the short term. Under our “adjusted” scenario, U.S. real GDP grows by 2.5% in 2025 (versus 2.4% under a reference scenario) and 2.2% in 2026 (the same as in the reference scenario). Given the uncertainty, these numbers are mid-point estimates of a range.  

Table E.1

We expect that the Federal Reserve will proceed with interest rate cuts but on a path that keeps interest rates higher than would otherwise have been the case. The Federal Funds Rate (upper level) would be about 3.75% by the end of 2025 and about 3.5% by the end of 2026. The yield on 10-year Treasury bonds would be about 4.5% at the end of both years.

The Outlook for Canada

Some months ago, the Canadian economy was on course to achieving real GDP growth of slightly above 2% annually in both 2025 and 2026, with inflation roughly at target.

Before the U.S. election, some domestic factors had already been altering short-term prospects.

First, after recognizing that temporary immigration had run out of control in 2023 and 2024, the Government of Canada announced a sharp tightening of programs for temporary workers and foreign students, and reduced permanent immigration targets for 2025 to 2027. Accordingly, after very rapid population growth in 2023 and 2024, the government is now projecting a small contraction of the population in both 2025 and 2026.

We think that migratory flows are unlikely to adjust as quickly as envisaged by the federal government—for example, not all temporary migrants will leave the country at the end of their visa—but the negative population shock will be significant. In our adjusted scenario, we estimate that this will depress real GDP growth. 

Second, the Ontario and federal governments have announced fiscal measures to boost temporarily the purchasing power of households. Additionally, we expect that federal and provincial governments in fact will spend more over our planning horizon than set out in their current fiscal plans. Altogether, this is likely to bump domestic demand slightly in 2025 and 2026.

Abrupt changes in U.S. policy pose the most significant risks to our economy. Even if, as per our assumption, President-elect Trump reconsiders the imposition of a 25% across-the-board tariff, there will likely be ongoing exposure to trade risks and to other impacts of the new administration’s economic agenda.

The Canada–United States–Mexico Agreement (CUSMA) will be reviewed by 2026. There are traditional irritants in the relationship, such as dairy, softwood lumber, aluminum and steel, and new ones—notably, Canada’s legislated Digital Services Tax. There is pressure to step up our spending to control both inbound and outbound flows of migrants across the border and to enhance our military spending and capacity.

The competitiveness of our business environment will be affected by the U.S. tax cuts and deregulation. Investors will take all of those parameters into account in deciding whether to invest and whether to do so north or south of the border.

Altogether, despite the strength of the U.S. economy, the Trump agenda will lead to diminished business confidence and investment, and to lower consumer confidence and spending in Canada in the short term. We estimate that this will reduce real GDP growth in Canada by 0.6 percentage point (pp) in 2025 and 0.5 pp in 2026 (mid-point estimates).

Given the above, under our adjusted scenario, real GDP in Canada grows by 1.5% in 2025 and 1.6% in 2026. Again, these are midpoint estimates of a wide range of possible outcomes given the considerable uncertainty around the impacts of the Trump agenda on Canada even before the application of tariffs on our exports to the United States.

Table E.2

In this scenario, inflation stays close to target and the Bank of Canada (BoC) reduces the policy interest rate to about 2.75-3% by the end of 2025 and hold it at that level until 2026. While softer domestic demand may suggest a slight acceleration of rate cuts, the BoC will be mindful of the effect of a lower exchange rate on inflation. With a strong U.S. dollar, we expect the Canadian dollar to be at approximately US$0.70 by the end of 2025, recovering slightly to about US$0.72 by the end of 2026. The 10-year Government of Canada bond yield would be around 3.4% at the end of both 2025 and 2026.

An Immediate Priority: Safeguarding the Vital Canada–United States Relationship

An across-the-board tariff in the order of 25%, or even 10%, would be hugely disruptive for the Canadian economy, and it would hurt a number of key U.S. sectors as well. Even if the new administration does not proceed with large tariffs immediately in 2025, an uncertain economic relationship with a constant threat of a tariff or other arbitrary actions by the United States would be severely damaging for Canada.

Thus, an immediate national priority is safeguarding the vital Canada–United States relationship.

The Government of Canada, with the shared leadership and participation of provinces and the private sector, can muster a response to the president’s agenda that is collaborative yet firm and aligned with our national interest.

A concerted response needs to convince President-elect Trump not to proceed with a tariff on Canadian goods—by demonstrating what Canada brings and can bring to the table to advance shared strategic and economic objectives.

We should also prepare for the eventuality that the president imposes tariffs.

Our response must comprise:

• advocacy in the form of a unified message to U.S. decision-makers;
• actions to demonstrate early responsiveness to President-electTrump’s priorities, including heightened security at the border, which is also in our national interest;
• negotiation to remove (to the greatest extent) the threat of tariffs and to establish a foundation to manage the relationship over the next four years;
• ongoing engagement to manage ongoing risks, including the renewal of CUSMA, and to build on opportunities for bilateral cooperation in such matters as national and economic security; and
• contingency planning to be ready, should tariffs be imposed, to retaliate in a smart, targeted manner and to roll out appropriately designed and scaled measures to mitigate impacts and importantly facilitate adjustment for exporters and workers.

Addressing a Critical Vulnerability: Investing in a More Productive Economy

Canada is entering a period of heightened uncertainty and deep structural change without strong economic momentum and with significant vulnerabilities.

While inflation has come down, households are still adjusting to a higher level of prices for food and shelter. On average, personal income and wealth have kept pace with inflation, or better, but this is not experienced or felt across all income or socio-economic groups.

Our foremost vulnerability is a poor productivity performance, which is holding back our growth potential, reducing our resilience to economic shocks and impairing our capacity to adapt.

Canada is not alone in lagging the United States in productivity growth. Other major economies like the EU and the United Kingdom are taking stock and contemplating bold steps to narrow the gap.

The pursuit of stronger productivity growth needs to be guided by a strategy that elicits the buy-in and participation of all levels of government and the private sector.

Public and private sector leadership must convey to the public that over the long term, productivity growth is the only way to generate rising incomes and the tax base to pay for public services for a growing and ageing population.

The productivity growth strategy must create the conditions, despite uncertainty and risk, to raise public and private investment and to realize the innovation potential of our enterprises for global market advantage.

In a prior Economic Outlook, we set out a target to grow non-residential investment as a share of GDP by close to 3 pp, to 17% of GDP, and to sustain this higher level of investment over many years.

In comparison, in a report to the European Commission, former central banker Mario Draghi set out a target to lift the investment share of GDP in the EU by up to 5%, more than at the time of the Marshall Plan.

Investment can be deployed productively in our traditional industries to capitalize on our resources, grow our exports and contribute to our economic and energy security. The strategy must also target world-class capacity for innovation, the commercialization of ideas and the financing and scale-up in Canada of innovative enterprises. It matters critically that the best-available technology, notably digital technology and artificial intelligence, be adopted at pace to grow productivity in all sectors.

All levers of policy need to be utilized: tax, regulation, competition, trade, immigration, education, infrastructure, procurement, innovation and industrial policy. Provinces have an important role to play.

While a strategy should not be captive to market incumbents—and indeed should encourage disruptive innovation—it should be developed and implemented together with the private sector.

Applying a Productivity Lens to the Pursuit of Other Priority Goals

Stronger productivity growth is not an end; it is a means to higher standards of living.

In a period of uncertainty and structural change, a productivity growth strategy must be advanced together with other critical priorities: enhancing national and economic security; transitioning to a lower-carbon economy; and strengthening our social infrastructure and services.

First, to address rising and evolving national security threats, meet our NATO commitments and strengthen our relationships with the United States and other allies, Canada needs to ramp up its spending on national defence significantly and quickly.

Defence spending must be driven by strategic and operational requirements, but to the greatest extent new investments should contribute to a more innovative and productive economy and achieve greater operational capability in the most cost-efficient manner.

Security for Canada and its allies is also a matter of building resilience in supply chains. There are immense opportunities through responsible development in the energy and critical mineral industries to grow our economy and enhance economic security. This potential must be unlocked.

Second, while the pace of the energy transition globally and in Canada will be a function of both policy and market factors, the direction of change is clear, and we should be guided by the need to build an energy system for a more productive, competitive and lower-carbon economy.

Governments and businesses can collaborate and share costs, risks and benefits towards clear priorities: decarbonizing our oil and gas supply; expanding our clean electricity supply; and building advantages in clean energy technology.

An absolute emissions cap for oil and gas that results in the shut-in of production capacity, the loss of export opportunities, and a leakage of emissions to other global producers is unadvisable.

Third, federal, provincial and even municipal governments must address our key social priorities, including immigration, housing, health care, education and lifelong learning in a manner that is in step with a productivity growth strategy.

We need to align net annual inflows of immigrants with the absorptive capacity of our economy and ensure that economic immigrants have the requisite skills and competencies to contribute to building a more productive economy. This requires more than tweaks to recent policy.

As the public and private sectors consider means of closing the housing supply gap, attention must be paid to the poor productivity performance of the construction industry over the past 15 years. Faster permitting could help ensure a more efficient deployment of resources. There is also scope to accelerate innovation, including through alternative materials and modular construction.

The Key: Establishing Clear Priorities and Building Policy Coherence

There is tension among policy imperatives, but there are also opportunities to bring them into alignment in advancing the national interest and building a more resilient and more productive economy that delivers rising incomes for Canadians.

It is vital that we safeguard the Canada–United States relationship, and this can be done while also advancing domestic priorities, including safer borders and increased military capacity in an uncertain world.

A productivity-growth strategy can concurrently help mobilize both public and private investment.

This will require a sustained, focused agenda with clear priorities, policy coherence and relentless execution over a period of not months but years under shared public and private sector leadership.

Similarly, businesses need to navigate short-term risks and uncertainty, and build contingency plans, while also developing and executing investment strategies to preserve and grow markets. Moving forward, our capacity to adapt to an uncertain world and to capitalize on new opportunities will be our foremost assets.