As the war in the Middle East escalates with no end in sight, economists are warning there could be a recession on Canada’s horizon.
Rising oil prices, a string of weaker-than-expected job reports, Canada’s first recorded annual population decline and trade tensions with the U.S. are converging to complicate the outlook for growth and inflation, experts say.
On Wednesday morning, the Bank of Canada announced it would hold its key rate at 2.25 per cent, but Governor Tiff Macklem warned there may be difficult decisions ahead.
“The biggest cost of the war in Iran is a human tragedy,” he said. “But it’s also an economic shock.”
In a briefing following the rate announcement, Macklem noted that geopolitical tensions, shifting trade relationships and structural changes, such as artificial intelligence and demographics, are clouding Canada’s economic outlook.
“Uncertainty is acute,” he said. “The range of possible outcomes has broadened.”
Since the U.S. and Israel launched a joint attack on Iran on Feb. 28, the cost of oil has risen dramatically, spiking as high as $100 (U.S.) a barrel, which could continue to squeeze consumers if Iran’s blockage of the Strait of Hormuz, a global oil conduit, persists.
Higher oil prices would eventually lead to more expensive food, consumer goods and transportation, economists say, which increases the likelihood that a rate hike could come later in the year.
“We could absolutely have a recession coming,” said CIBC deputy chief economist Benjamin Tal. “If you look at every recession over the past 40, 50 years — with exception of COVID — they were led by an oil shock.”
Macklem said the Bank of Canada will respond as needed as risks evolve and play out in the economy.
“We are prepared to look through the immediate impact of higher energy prices on inflation,” Macklem said, “but we are not going to allow that to spill over and become persistent inflation.”
GDP shrank by 0.6 per cent at the tail end of 2025, following a 2.4 per cent increase in the previous quarter. Though growth was weaker than the bank had forecast, Macklem explained the discrepancy was because “inventories were drawn down by more than we expected.”
In an announcement Wednesday, the U.S. federal reserve bank also said it was maintaining its target range for the benchmark federal funds rate at 3.5 to 3.75 per cent. The bank noted uncertainty over the economic outlook and said it will continue to monitor labor market conditions, international developments, and inflation pressures and expectations.
The U.S. announcement could be bad news for Canada, said Avery Shenfeld, chief economist at CIBC Capital Markets.
“Although we are an oil exporter, we obviously export other products to the U.S. and the rise in energy prices is delaying … further rate cuts in the U.S. to help their economy,” Shenfeld said.
“If higher gasoline prices constrain consumer spending in the U.S., there are sectors of the Canadian economy that will feel that.”
Manulife global chief economist Alex Grassino said he views Canada “as the test case for what you could see in the U.S.” He said both countries are coping with decreased migration and a change in the working age population that could affect how the nation’s economies interact.
Grassino added that he predicts “fragile and modest growth” in Canada for the next year or so, as the country contends with a shifting trade dynamic.
Canada is also grappling with its first population decline on record, according to 2025 data released by Statistics Canada on Wednesday, which could also weaken the economic outlook.
“When the population is shrinking, it does cut the demand for goods. There’s less consumer spending,” BMO’s chief economist Douglas Porter explained.
Tal noted that Canada saw rapid population growth following the pandemic, which may set the economy up for more damage now that the population has declined.
“As we all know, Canada needs immigrants like oxygen, but it was simply too much of a good thing, too fast,” he said. “Over the course of breakfast we got 1.5 million people into this country. That was a policy mistake.”
The population decrease could also explain Canada’s most recent jobs numbers, which were worse than anticipated.
Porter said the Bank of Canada “pretty clearly suggested” the economy had been weaker than expected before the war’s outbreak, and their policymaking should reflect that.
“When the job market is as soft as it has been recently, the Bank of Canada should not be considering raising interest rates,” Porter said.
Shenfeld says he believes Canada has skirted a recession, but there was a cost, as there is now a higher unemployment rate. The end result is a less-than-ideal labour market that policies will not be able to remediate until 2027, he said.
“It’s a case of disappointment,” Shenfeld explained. “We still have some signs of economic growth, they’re just not as robust as we would like them to be.”
