Canada has entered a recession brought on by its escalating trade dispute with the U.S., according to a new forecast from Oxford Economics. But the economic drag may be softened over time thanks to a sharp increase in federal defence spending, which is also expected to push bond yields higher.
In its latest outlook, Oxford revised its GDP forecast slightly higher for 2025 to 0.9%, up from 0.8%, to reflect Ottawa’s recent pledge to raise military spending to 2% of GDP by the end of this fiscal year. The government also plans to steadily ramp up funding to meet NATO’s new 5% target by 2035.
That additional spending will support growth in later years, but Oxford expects it to be deficit-financed, raising the federal debt burden and long-term borrowing costs. Its new forecast puts the 10-year Government of Canada bond yield at 4.0% by 2027, up from 3.84% in last month’s estimate.
Higher yields putting pressure on mortgage rates
Oxford’s updated forecast arrives amid elevated bond yields, which have already been impacting fixed mortgage rate pricing. As Canadian Mortgage Trends previously reported, lenders across the country have been steadily increasing rates across various terms in recent weeks, reflecting higher funding costs and economic uncertainty.
As for variable-rate pricing, Oxford expects the Bank of Canada to hold its policy rate at 2.75% for now as it weighs the opposing forces of slowing growth and persistent inflation risks.
While Oxford doesn’t rule out another one or two quarter-point rate cuts, it says the policy rate is unlikely to fall below 2.25% unless inflation continues to ease and the economy needs additional support.
Tariffs remain the swing factor
The forecast was shaped by significant uncertainty around Canada–U.S. trade relations. At the time, the firm warned that without a new economic and security agreement, and if U.S. President Donald Trump followed through on his threat to impose 35% tariffs on non-USMCA Canadian goods, the recession could deepen and drag on.
“U.S. tariffs will lead to fewer Canadian goods exports, while uncertainty and a weaker job market will hurt domestic demand,” the report said. Oxford projects a 0.8% peak-to-trough GDP contraction from Q2 to Q4 2025, and anticipates the unemployment rate could rise to 7.6% (from 6.9% currently) as job losses spread beyond trade-exposed sectors.
But while growth is expected to remain weak, inflation pressures are building. After falling to 1.9% year-over-year in June, Oxford says headline inflation could rebound to 3% by mid-2026 as temporary Canadian tariff relief expires in October and supply chain disruptions feed into prices.
Outlook snapshot
| 2024 | 2025 | 2026 | 2027 | |
|---|---|---|---|---|
| GDP growth | 1.6% | 0.9% | 0.4% | 3.0% |
| CPI inflation (y/y) | 2.4% | 2.3% | 2.6% | 1.9% |
| Unemployment rate | 6.4% | 7.2% | 6.7% | 6.2% |
| 10yr bond yield (end of period) | 3.23% | 3.65% | 3.91% | 4.00% |
| Policy rate | 3.25% | 2.75% | 2.75% | 2.75% |
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Last modified: August 7, 2025
