Vanguard’s mid-year outlook for the economy

Positive news for GDP growth, but trouble in labour markets

In my previous post, I covered Vanguard’s 2025 outlook for monetary policy and inflation and how the Bank of Canada is likely to react (don’t expect steep rate cuts anytime soon). We continue our mid-year outlook with a look at GDP growth and labour markets.

In Q1, 2025 GDP surprised to the upside with 2.2% growth largely due to tariff frontrunning from U.S. firms. Declines in wholesale trade and manufacturing resulted in GDP contracting by 0.1% in April as this frontrunning dissipated, but we remain optimistic about an imminent improvement in U.S.-Canada trade negotiations while recent indicators suggest that domestic momentum may be stabilizing.

Nominal wage growth remains supportive, and unemployment increases are concentrated among younger workers, who account for a relatively small share of overall consumption. We expect 2025 GDP growth of 1.25%, but our near-term outlook remains highly dependent on U.S.-Canada trade negotiations, of which we remain optimistic.

With one of the lowest effective tariff rates among major U.S. trading partners, prolonged negotiations between U.S. and other nations may support Canadian exports in the near-term. Slowing population growth has also reduced potential GDP while easing monetary policy has provide relief to household as household debt-to-income in Canada fell to 171.1% in Q1 2025, the lowest rate since Q1 2021.

Longer term, we see some positive news for Canada’s potential GDP as the federal and provincial governments make progress on reducing interprovincial trade barriers. Ottawa removed 53 federal exemptions from Canada’s free trade agreement that inhibited interprovincial trade on provincial carve outs, most relating to federal procurement rules. Additionally, some provinces have been negotiating with each other to remove trade barriers. Issues such as regulatory differences between provinces, geographic restrictions on goods, and impediments to labour mobility have negatively impacted Canada’s productivity and GDP per capita.

It's too early to assess the impact of these measures and those outlined in Bill C5. We have recently seen an increase in Canada’s GDP per capita as the chart below shows. Slowing population growth for six consecutive quarters along with strong GDP numbers for Q4 2024 and Q1 2025 have boosted Canada’s GDP per capita.

Labour markets

Canada’s labour supply has slowed, predominantly due to caps on temporary foreign workers and international students, but employment growth has slowed even more. There has been “virtually no employment growth” since January after strong gains in the fall.

The country’s unemployment rate is now its highest in nine years, outside of the pandemic. There are three people unemployed for every vacancy and the average duration of unemployment has risen to 22 weeks, up from 18 weeks a year ago.

The labour market is a tale of two cities.

The first city is comprised of gainfully employed workers who have been part of the workforce for a while. They are doing reasonably well despite an unemployment rate of 7% as layoffs have not risen. Quits levels are low and the ones impacted negatively are those concentrated in trade-related sectors. The worst hit is the manufacturing sector, which has now seen four consecutive months of job losses.

The other city is comprised of new entrants and those seeking to enter the labour force, particularly Canada’s youth. They have not had it easy as the youth unemployment rate is now 14.2% and the rate for returning students is even more elevated at over 20% (see chart below).

Given the sharp rise in uncertainty companies are less willing to hire new workers but at the same time not willing to lay off experienced workers. Trade development will play a crucial role in the labour markets. We expect the unemployment rate will reach 7.5% by year-end.

Ashish Dewan CFA, CFP is Senior Investment Strategist at Vanguard Investments Canada. Excerpted from Vanguard’s “Economic Outlook for Canada – Q2 2025”.

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