Canada enters technical recession as spending declines

Canada’s economy shrank by 0.6% on an annualized basis in the fourth quarter of 2025, making it the sole G7 nation to post negative growth during the period. The contraction was driven primarily by significant inventory drawdowns among businesses, with weak government and business spending compounding the downturn.

For context, a 0.6% annualized decline translates to roughly a 0.2% quarterly contraction.

What drove the contraction

The primary culprit was businesses pulling back on inventories. Companies sold off stockpiles rather than ordering new goods, which subtracts from GDP calculations. Household spending, government expenditures, and exports did provide some cushion, but those offsets weren’t enough to keep the headline number above zero.

Full-year real GDP growth for 2025 came in at 1.7%. That’s the slowest annual pace Canada has posted since 2020, when the pandemic brought the global economy to its knees.

Unemployment has also been creeping upward, hovering between 6.5% and 6.8% through late 2025 and into early 2026.

Early signs of a rebound, barely

Monthly GDP data for early 2026 suggests the bleeding may have stopped. January posted 0.1% growth, followed by 0.2% in February. Forecasts suggest Q1 2026 could land somewhere between 1% and 1.7% annualized growth.

A technical recession requires two consecutive quarters of negative growth. If Q1 2026 does come in positive, Canada would narrowly dodge that label despite the Q4 2025 contraction.

The Bank of Canada currently projects GDP growth of around 1.1% for the full year of 2026. US trade tariffs remain a persistent headwind, with business sentiment cautious and domestic demand subdued.

What this means for investors

For equity investors, the weak business spending and inventory drawdown trend suggests corporate earnings may face pressure in sectors tied to domestic demand and manufacturing.

With growth projected at just 1.1% and unemployment drifting higher, there’s a case for continued accommodative monetary policy. But inflationary pressures, partly stoked by US tariffs driving up import costs, complicate the calculus.

For fixed income markets, the weak growth backdrop could keep Canadian bond yields suppressed relative to other G7 peers.

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