Canada’s Economic Crossroads – Recession or Recovery?
The Canadian economy faces a critical juncture, with economists divided on whether the country is headed for recession or poised for modest growth. Warnings about the impact of rising interest rates, a cooling labour market, and slowing global demand have intensified, while optimists point to improving inflation trends and resilient business investment. As headwinds mount, Canada’s economic future is uncertain, with both risks and opportunities shaping the outlook for 2025.
Recession Signals: Poloz and RBC’s Warnings
Former Bank of Canada Governor Stephen Poloz has been vocal about the growing recession risks. He highlights key indicators—rising unemployment, shrinking per capita economic growth, and a mortgage renewal crunch—that suggest Canada may already be in recessionary territory. The unemployment rate reached 6.5% in August, up significantly from its post-pandemic low. Poloz noted that this rise, coupled with weak per capita GDP growth, which has now declined for four straight quarters, is a clear sign of economic stress. "If we didn’t have the population growth, the economy would be shrinking by about 2%," he said during a recent webinar.
Adding to the concerns, RBC’s latest economic report points to declines in productivity throughout 2024, with early data signalling that “decades-high population growth has masked this recession-like economic backdrop.” Job openings are also declining, signalling that labour demand is waning—a worrying sign for a labour market that has struggled to keep up with Canada’s surging population.
RBC’s report also highlights the growing financial strain on Canadian consumers. “Per person after inflation household spending is 2.6% below its post-pandemic peak and down 2% from pre-pandemic 2019 levels as higher prices and interest rates cut into purchasing power.” Rising debt payments and delinquency rates, fueled by aggressive interest rate hikes over the past 18 months, are squeezing household budgets further. As mortgage renewals come due at higher rates, consumer spending is expected to weaken even more.
The Optimistic Outlook: Growth on the Horizon?
Despite these warnings, some economists are more optimistic about Canada’s prospects. A recent TD Bank report acknowledges the challenges and points to a recovery. TD expects that “after an economic slowdown in 2023 and 2024, Canadian output will rebound in 2025 and 2026.” The report forecasts a modest 1.1% GDP growth this year, followed by stronger performance next year, driven by lower interest rates and renewed business investment in infrastructure and renewable energy projects. TD also notes that Canada’s inflation rate is expected to hit the Bank of Canada’s 2% target by the end of the year, easing pressure on the central bank to keep rates elevated.
Forecast Canadian Real GDP (%)
Although GDP growth has been weak, TD argues that much of this underperformance is linked to temporary disruptions, such as wildfires and a federal workers’ strike in the second quarter, rather than structural issues. Moreover, while consumer spending remains subdued, TD sees a rebound in housing investment and business activity as borrowing costs ease in 2024.
This view aligns with some broader global trends. The U.S. economy has shown remarkable resilience, with GDP growth expected to remain above 2% this year. This has helped stabilize North American economic conditions, despite slower growth in other major economies like China and Germany. The easing of inflation globally, combined with more accommodative monetary policies, provides a more supportive backdrop for Canada’s economic recovery next year.
Labour Market Imbalance and Population Growth
The rapid growth in Canada’s population, largely driven by immigration, is another key factor shaping the economic debate. The surge in the labour force has not been matched by corresponding gains in employment, leading to higher unemployment. According to RBC, the 0.5 percentage point rise in the unemployment rate over the past four months is the largest increase outside of the pandemic since the 2008-09 recession.
However, RBC notes this increase is due to slower hiring, not a spike in layoffs. Employment grew by 19,000 jobs per month over the last four months, but this has not been enough to keep up with labour force expansion, and employment growth is slowing. Poloz has argued that the disconnect between population and economic growth is masking deeper issues. “We are getting into the most stressful phase of mortgage renewal,” he said, warning that higher mortgage payments will further strain household finances and curtail consumer spending.
Central Bank Dilemma: Rate Cuts or Caution?
The encouraging news is that inflationary pressure is easing as the Canadian economy softens, which allowed the Bank of Canada to loosen its monetary stance with three consecutive 25-basis-point cuts to the overnight rate since June.
However, interest rates remain elevated enough to restrain economic growth rather than stimulate it. The lag between changes in policy rates and their impact on household borrowing means borrowing costs for the typical Canadian household will continue to rise, especially for those renewing fixed-rate mortgages set during the ultra-low rates of the pandemic era.
Nevertheless, the BoC is expected to continue its cautious easing, helping to moderate the consumer payment burden and setting the stage for a modest economic recovery in the latter half of 2025.
TD Bank also anticipates further rate cuts but expects the Bank of Canada to proceed cautiously to avoid overcorrecting. With inflation forecast to hit 2% by year-end, the risk is that overly aggressive rate cuts could reignite price pressures. “The neutral overnight rate for Canada is around 2.25%,” TD notes, suggesting that there is still room for monetary easing, though it will likely be gradual.
From the Frying Pan to the Fire?
As Canada navigates this period of economic uncertainty, the outlook remains deeply divided. Stephen Poloz and RBC warn of recessionary conditions driven by rising unemployment, slowing global growth, and a mortgage renewal crisis. On the other hand, TD Bank and other optimists see a pathway to recovery supported by lower interest rates, investment in infrastructure, and easing inflation.
What is clear is that Canada’s economy is in flux, and if rates begin to drop quickly, it will be because recessionary indicators are flashing red. Otherwise, we can expect the Bank of Canada rate to drop in a measured and orderly fashion toward 2.25%. That will bring down variable-rate mortgages, but it provides no guarantees for fixed-rate mortgages.
