It is that time of the year and every good economist should
offer their thoughts for the coming year’s economic performance. However, forecasting the outlook for Canada’s
economy in 2026 is ultimately an exercise in caution given the large number of domestic
and international economic moving parts.
The trade and tariff situation between Canada and the United States
including the future of CUSMA is an important variable as is the large number
of proposed infrastructure and nation building projects and increased defence
spending all which are sources of stimulus.
Then there are the efforts at export diversification and the role of
prices for Canadian resource commodities. At the same time inflation and
economic uncertainty may dampen consumer confidence and spending along with the
headwinds of flat home construction and population growth which have been major
drivers at least in terms of overall though not per capita economic growth.
A worst-case scenario would see CUSMA falling apart and a
new set of higher tariffs shocking the Canadian economy and prompting capital
outflow. New tariffs would further depress
exports. If planned national
infrastructure projects are bogged down, then that source of stimulus would not
be there. The economy would likely enter
a recession with the loss of several hundred thousand jobs and the unemployment
rate rising to the 8-9 percent range though inflation would likely moderate to
below the 2 percent target. On the plus
side, lower inflation would result in downward movement of the Bank of Canada
Overnight Rate to below 2 percent.
Real GDP growth in this worst-case scenario would be
negative but hopefully not catastrophic given the large amount of fiscal
stabilization government spending is already injecting into the economy and the
self-directed efforts by more Canadians to spend and travel domestically. However, the Canadian political situation
could be a factor in further making a worst-scenario case worse if the minority
government falls plunging the country into the uncertainty of a federal
election and both Alberta and Quebec announce they are going to hold
referendums on separation leading to additional outflows of capital and
investment.
However, there are reasons to be optimistic that 2026 will
be at least as good as 2025 if not better.
Indeed, the recent update of GDP growth numbers by Statistics Canada
suggests the Canadian economy has more steam than one might expect. In the face of trade disruption and
uncertainty, Canada’s economy in 2025 has been more resilient than one
initially might have thought. High government spending for the time being is
already injecting stimulus into the economy and the self-directed efforts by
more Canadians to spend and travel domestically has been its own domestic
stimulus program. In the end, while
there has been an impact of U.S. tariffs on specific Canadian sectors such as
autos, steel and aluminum, it remains that most Canadian trade with the United
States that is under CUSMA remains tariff free.
Going forward, despite President Trump’s rhetoric, the
United States does need Canadian exports and there is eventually going to be
some type of trade agreement that will ensure reasonable access to the American
market. If all goes well in terms of
resolving trade issues with the United States, there is no major international
crisis that disrupts trade, there is a start on one or two major infrastructure
projects, some stimulus from defence spending, continued export diversification
and commodity prices strengthen, then one might even see robust real GDP growth
in the 2-3 percent range with the unemployment rate falling to the 5-6 percent
range as hundreds of thousands of new jobs are added to the economy. Indeed, faster than expected growth may put
inflation well above the Bank of Canada target range resulting in higher
interest rates and even a higher exchange rate relative to the U.S. dollar.
So, economic outcomes in 2026 are uncertain but the evidence
suggests that when push comes to shove, the U.S. will have to negotiate some
type of arrangement with Canada and Mexico if it does not want to harm its own
economic welfare. Even a cross between
the best- and worst-case scenarios outlined here would be a reasonable economic
outcome in terms of growth and employment.
I think guarded economic optimism
is a good way to sail into the New Year.
