Canada's economic growth is expected to slow following a breakdown in trade talks with the United States. The Parliamentary Budget Office (PBO) released a revised outlook on Tuesday, lowering its projections for real gross domestic product (GDP) growth because of escalating trade tensions and new tariffs.

Why is the economic growth forecast falling?

The downward revision stems from a trade war that intensified in June. After negotiations between Canada and the U.S. collapsed in late August, both nations implemented new rounds of tariffs.

According to the PBO, these trade measures have created significant uncertainty. The watchdog said the added measures are "weighing on growth in real output," which refers to the total value of goods and services produced within the country.

The new projections are:

  • 2026 growth: lowered to 0.9 per cent from 1.1 per cent.
  • 2027 growth: lowered to 1.5 per cent from 1.6 per cent.

What are the fiscal implications?

The slower economy is expected to widen the federal shortfall. The PBO now expects the government to run a shortfall of about $63.3 billion in the 2026-27 fiscal year, growing to roughly $70.2 billion the following year.

On average, annual shortfalls are expected to be $3 billion higher than previously estimated for the period between 2026 and 2031. This increase is driven by new spending measures and rising debt charges. Federal debt charges are projected to reach $59.3 billion this fiscal year, a significant increase from $24.5 billion in 2021-22.

How will inflation and interest rates respond?

Inflation is expected to remain somewhat elevated due to higher energy costs. The PBO anticipates an average inflation rate of 2.8 per cent in 2026, which should ease to 2.4 per cent in 2027.

To manage these price expectations, the watchdog assumes the Bank of Canada will begin raising its policy rate in early 2027. The rate is expected to reach 2.75 per cent by the middle of that year.

FAQ

What is causing the increase in the federal shortfall?

The shortfall is rising because new government spending and higher interest payments on accumulated debt are outpacing revenue gains.

What will determine long-term prosperity?

Future economic health depends on whether recent investments in capital budgets can successfully boost national productivity and capacity.