RBC Economics produces macroeconomic and sector-specific insights grounded in our in-depth knowledge of markets across North America and worldwide. Our team of experienced economists delivers leading economic analyses and ideas to inform decision-makers across the public, private, and nonprofit sectors.
Cynthia Leach, Assistant Chief Economist, RBC Economics
Nathan Janzen, Assistant Chief Economist, RBC Economics
Robert Hogue, Assistant Chief Economist, RBC Economics
As Canadian businesses continue to experience a mix of challenges and opportunities, it’s important to understand today’s economic environment. External pressures like tariffs, supply chain bottlenecks, and interest rate uncertainty are just some of the driving factors impacting business growth. We asked the RBC Economics team to share their insights and what strategies Canadian businesses can implement to successfully navigate a whole new world in 2025.
1) What’s your outlook for the Canadian economy over the next 12 months, and what should small business owners be monitoring closely?
NJ: The Canadian economic outlook remains uncertain and dependent on U.S. tariff policies. Recent developments have been encouraging, at least relative to a range of potential significantly worse outcomes that looked more likely in March and April —the U.S. has stepped back from the most severe global tariff threats, dialed back 100%+ tariffs on China, and critically left an exemption for duty free trade with Canada and Mexico on products compliant with CUSMA largely in place.
However, the average effective U.S. import tariff rate still stands at 13%—the highest since the 1930s. Limited tariffs still affect certain Canadian exports not covered by CUSMA, as well as steel and aluminum products, and non-U.S. content in motor vehicles. Nevertheless, by our count approximately 86% of Canadian exports to the U.S. remain duty-free, giving Canada the lowest effective tariff rate on U.S. imports globally at about 3.6%.
While that relative tariff advantage means Canadian exporters may maintain, or even gain, U.S. market share, broader U.S. tariffs on other countries are so large that the overall size of the U.S. import market could shrink as higher costs shrink consumer and business spending.
We don’t anticipate current tariffs causing recessions in either the U.S. or Canada but expect slower growth and Canadian unemployment rising above 7% (from 6.6% on average in Q1) before conditions improve later this year and into 2026, assuming trade disruptions ease.
2) The term “k-shaped economy” is often used to describe today’s uneven economic landscape. Can you expand on what this means in the Canadian context, and do you see these divergences persisting?
CL: Economists are getting better at highlighting the varying economic experiences of different subgroups. The “k shape” comparison refers literally to the shape of the letter, where part of it is going up and part of it is going down.
In the U.S., households in the top income quintile account for half of all consumption expenditure—the primary GDP driver. Consequently, factors affecting these households’ wealth and confidence, such as stock market performance, provide significant insight into broader economic trajectories.
Canada exhibits its own K-shaped pattern. Lower-income households have faced particular hardship over the past two years from high inflation and interest rates. Meanwhile, newcomers and younger workers have disproportionately suffered from weakening job markets, with young urban workers confronting exceptionally high housing costs.
Looking ahead, new divergences may emerge. Trade-exposed sectors could experience disproportionate impacts from tariff policies, uncertainty, and slowing growth.
3) What is your outlook on interest rates? What does it mean for Small Businesses and how can they position themselves in a shifting rate environment?
NJ: The Bank of Canada is likely nearing the end of its easing cycle, which began earlier and has been more aggressive than most advanced economies. The BoC has already reduced the overnight policy rate to 2.75% from 5.00% before it began its rate cutting cycle in June 2024. Our base case projects an additional 0.5 percentage point cut to 2.25% by summer 2025.
The direction of interest rates remains highly contingent on an unusually uncertain economic outlook, so thinking about the way risks to that base case assumption might evolve is even more important than usual. Canada’s limited retaliatory tariff measures should limit the impact of the trade war on consumer prices beyond specific products like vehicles and certain foods. We expect this would allow the central bank flexibility to lower rates if needed without endangering its 2% inflation target, while accounting for potential fiscal stimulus from governments.
That means if the economic outlook were to worsen, some combination of additional fiscal stimulus and lower interest rates will step in to help bridge a reduction in demand. If economic growth were to surprise on the upside, interest rates might be higher than expected.
It’s important to remember that businesses typically borrow at term rates influenced by global markets, not just the overnight rate. U.S. inflation concerns and government borrowing levels are keeping a floor under term rates, with some spillover to Canadian markets. Consequently, longer-term rates haven’t declined as much as shorter-term rates this year, though we expect them to drift lower by year-end.
4) RBC has described the current environment as being weighed down by an “extraordinary uncertainty tax.” How is that uncertainty affecting small business confidence, investment and planning?
NJ: Economic uncertainty reduces investment as returns become less predictable and causes decreased consumer and business spending. Even without additional tariffs, uncertainty hampers business sentiment and investment—ultimately slowing productivity growth, profits, and wages.
Canadian productivity has lagged behind peers for decades, with business investment suppressed by multiple shocks including a pull-back following the 2008/09 recession, the 2015 oil price collapse, the pandemic, and recent inflation and interest rate increases in 2022 and 2023.
Encouragingly, business confidence has recently shown improvement from very low levels earlier in the spring. CFIB data indicates relatively resilient current condition assessments, and while the 3- and 12-month outlooks remain negative, they’ve improved from March lows when Canada faced larger and disproportionate direct tariff threats. Lower interest rates and strong corporate cash positions (over 30% of GDP) provide capacity for investment.
Nevertheless, uncertainty will likely continue to constrain business investments throughout the coming year.
5) Is the trade war only impacting Canadian exporters or is the turbulence also spreading to small businesses in domestic industries?
RH: Trade tensions will impact Canadian businesses with direct or indirect U.S. relationships but small domestically oriented businesses could also be disrupted by secondary effects.
Home builders are one example. Economic uncertainty has eroded consumer confidence, causing potential homebuyers to delay purchases. This spring has seen home sales plummet, with demand for new construction virtually disappearing in major Canadian markets. Builders currently remain occupied with projects-initiated years ago, but the diminishing pipeline of new developments is dimming the outlook for a sector that largely consists of small businesses.
The good news is that governments are actively removing housing development barriers. Combined with substantially lower interest rates over the past year, these changes should improve prospects for construction and renovation businesses once economic stability returns. Years of housing shortages have created substantial pent-up demand, and addressing Canada’s housing crisis will require the participation of numerous small businesses across the construction ecosystem.
6) What kinds of policy measures do you think will be most important to support growth and resilience within the small business sector?
CL: The support needed for small business resilience has two critical dimensions: broader foundations for the economy as a whole and targeted small business measures.
Canada must diversify export markets and stimulate business investment—this is a longstanding challenge that has contributed to slower living standard growth compared to global peers. This task becomes more difficult given our projected weak growth environment and persistent U.S. policy uncertainty.
So, there has to be an important role for government. Here, transportation infrastructure is a big one. There are 7.9 billion non-U.S. potential customers for Canadian exports out there in the world. Meanwhile, we have an incredible collection of free trade agreements whose benefits are not being maximized and ports, rails, and pipelines that have been reaching their limits.
This would benefit small business. We then have to consider targeted measures to account for small business challenges in scaling, upskilling workers, or investing in AI and other productivity enhancing tools. We also know small businesses are half as likely to be exporters and are also more likely to face failed export attempts. This would be a good place to start.
7) We’ve talked a lot about disruption and uncertainty. But in your view, are there still pockets of opportunity out there for small businesses?
CL: A more fragmented trading system – if that is indeed where we’re headed – is bad for global growth. That’s the negative longer-term backdrop that animates this conversation.
But in the near term, we have to account for some bright spots. Canada has secured a relatively advantageous position regarding U.S. tariffs—facing approximately 3.5% average rates on U.S. imports from Canada versus the minimum 10% imposed on most countries outside North America. Though targeted tariffs and uncertainty will certainly impact growth, Canadian households are gaining strength through interest rate normalization. A drop in Canadians traveling to the United States means more of those travel dollars will potentially be spent within Canada. Per capita GDP is projected to resume growth later this year, and Canada maintains both fiscal and monetary policy flexibility to buffer against additional shocks.
Beyond that near-term silver lining, though, the typical refrain applies – the discomforts of disruption breed opportunity.
We’re witnessing emerging consensus around addressing longstanding challenges like interprovincial trade barriers. Ontario has already established agreements with Manitoba, Nova Scotia, and New Brunswick to reduce bilateral barriers, while Prime Minister Carney has committed to eliminating federal exemptions to free trade by July 1st. Falling internal trade barriers represent substantial opportunities for small businesses.
Get more economic and business insights at RBC Economics and RBC Tariffs Navigator for Business.
