Canada's Economy Ends Q1 on A Softening Note Ahead of Deepening Downside Risks Driven by U.S. Policy, Says Scotiabank
3min read Scotiabank’s latest analysis paints a cautious picture for Canada’s economy, with the first quarter of 2025 marking a turning point toward slower growth as U.S. policy risks intensify. While Canada’s GDP is projected to grow 1.7% in 2025—slightly above its neighbor to the south—the outlook is clouded by escalating trade tensions, regulatory upheaval in cryptocurrency markets, and the lingering threat of inflation. The report underscores that the U.S. remains the primary source of uncertainty, with its volatile trade policies and geopolitical posturing creating a ripple effect across Canada’s economy. As businesses brace for potential tariff shocks and central banks navigate a tricky path between growth and price stability, investors must weigh the risks of prolonged softness against opportunities in resilient sectors.
Trade Policy Uncertainty: The Elephant in the Room
The report identifies U.S. trade measures as the single largest risk to global economic stability. Proposed tariffs on Canadian and Mexican non-energy exports—delayed but not canceled—threaten to impose an effective 2.7% tariff increase on U.S.-bound goods. Even without immediate implementation, this uncertainty has already led to supply chain disruptions and business caution. Canadian exporters face dual pressures: retaliatory tariffs from China and the risk of broader U.S. sanctions violating the Canada-United States-Mexico Agreement (CUSMA).
"text2img>A map illustrating the intricate trade routes between Canada and the U.S., highlighting key sectors like automotive and energy.
The automotive sector, which accounts for nearly half of U.S. auto imports, is particularly vulnerable. Pending U.S. decisions on tariffs for automotive parts—such as engines and secondary components—could force Canadian manufacturers to absorb higher costs or relocate production, threatening jobs and competitiveness. Meanwhile, the Bank of Canada (BoC) projects a 3.0% policy rate by mid-2025, aiming to cushion the economy. Yet rising wage pressures and inflation risks could force a pause or even hikes if expectations spiral.
Beyond Tariffs: Regulatory and Structural Challenges
Canada’s woes extend beyond trade. The report highlights DOGE-linked job losses—a reference to regulatory pressures on cryptocurrencies like Dogecoin (DOGE). U.S. policies, including the Inflation Reduction Act (2022) and proposed SEC guidelines, forced Scotiabank to cut 1,200 roles in technical and compliance departments by mid-2025. These cuts, driven by U.S. demands for stricter crypto oversight, underscore how non-trade policies can destabilize Canadian financial institutions.
Structurally, Canada faces long-term drags: weak productivity growth and slower population expansion due to immigration policy changes. Meanwhile, U.S. tax reforms and deregulation may divert investment away from Canada, further weakening competitiveness. The BoC warns that a tariff-driven inflation shock could force it to prioritize price stability over growth, tightening financial conditions and stifling consumer spending.
Global Dynamics and Policy Spillovers
The U.S. slowdown—projected at 1.4% GDP growth in 2025—is compounding Canada’s challenges. Reduced U.S. demand and retaliatory measures from China (e.g., 34% tariff hikes on U.S. goods) risk disrupting global supply chains. Mexico, similarly exposed, faces sub-1% growth in 2025, while Latin American nations like Chile and Peru are outperforming with 2.5–3% growth, driven by improved investment and household spending.
Geopolitically, the report notes a global shift toward self-reliance. Europe is accelerating investments in economic and defense resilience, reflecting diminished trust in U.S. leadership. For Canada, this means a world where trade partnerships are increasingly fragmented, and diversification is critical to avoiding overexposure to U.S. policy swings.
Conclusion: Navigating the Storm
Scotiabank’s analysis leaves little room for optimism. Canada’s 1.5% GDP growth forecast for 2026 hinges on the assumption that no broad-based tariffs violate CUSMA—a fragile hope given the U.S. administration’s erratic trade stance. If escalation occurs, Canadian growth could fall below U.S. levels, deepening the economic divide.
Investors should prioritize sectors insulated from trade volatility, such as tech (e.g., Toronto-headquartered Shopify), renewable energy, and high-quality government bonds. Meanwhile, equities in U.S.-exposed industries—like automotive and manufacturing—face downside risks. The report’s warning on inflation also suggests favoring assets that hedge against price pressures, such as commodities or inflation-linked bonds.
As central banks walk a tightrope—Fed rate cuts versus BoC rate stability—the path forward is fraught with uncertainty. With U.S. policy risks dominating the outlook, Canada’s economy remains a barometer of global resilience to protectionism. For now, the best strategy is to prepare for the worst while hoping for the best—and stay vigilant.
