Cautious Optimism on Canadian Consumers

Aside from tariffs, consumer expenditure growth—or the lack thereof—will drive the fortunes of the Canadian economy this year. Household spending accounts for more than half of the nation’s economic activity. While we think consumption could be a source of strength again in 2025, the outlook is extremely fragile.

Strength in 2024

Last year, as a significant number of mortgages renewed at higher rates and the unemployment rate rose, it was an open question whether households would need to pull back on discretionary spending. While many households did make adjustments to their finances, it wasn’t enough to derail the momentum of consumer spending. In part, that was because population growth continued to add new consumers to the Canadian economy. But the resiliency of consumption was also due to some surprising dynamics in the labour market.

Typically, an elevated national unemployment rate portends slower spending growth and a rise in mortgage arrears. Not so last year. That’s because the increase in joblessness primarily reflected the difficulties of newcomers and recent graduates in finding work. Given that these demographics don’t tend to have much debt or spend a lot of money, the rise in unemployment didn’t impact the economy as much as it has in the past. Job separation, a proxy for layoffs, remained very low last year. Importantly, that meant that households that were approved for and had taken on a lot of debt maintained stable incomes.

Rising wages also drove healthy disposable income growth for those that were employed. According to our analysis, wage growth has been particularly strong for workers in lower-paid jobs. Given that those employees tend to recycle income gains back into spending relatively quickly, such wage growth likely contributed to the resiliency of spending in 2024.

New Year, New Challenges

This year, however, will see new challenges as some economic tailwinds turn into headwinds. The number of temporary residents in the country is plunging. While the federal government might not fully implement its very aggressive plan to shrink the population, it’s likely that the pace of growth will slow to a crawl this year from the previous sprint.

The only silver lining is that the dwindling pool of temporary residents might not inflict as much pain on the economy as some businesses fear. The declining population of temporary residents in Canada has thus far been driven by a significant reduction in the number of international students in the country. As mentioned above, this demographic hasn’t been a significant source of spending and so will have less of an impact on the overall pace of consumption growth.

As a result, we’re cautiously optimistic that household spending growth cools off only slightly in 2025. However, much depends on Canadians spending more per capita.

Keys to Success

With inflation back down to the central bank’s target, incomes are once again rising faster than consumer prices. That’s a necessary ingredient for an acceleration in per person spending growth.

The decline in inflation has, of course, also opened the door to lower interest rates. While lower rates probably helped buoy consumer spending to some extent last year, further declines will be key in keeping growth in household expenditures on track. With so many mortgages facing the prospect of material payment shocks when they come up for renewal this year, the Bank of Canada will need to keep cutting rates to keep a lid on arrears. Measures of household wealth and debt suggest that there is some scope for consumers to draw from savings or borrow more to prop up spending, but it looks like some households are already showing signs of being financially stressed.

Despite the good news on the ability of households to service their mortgage debt last year, many fell behind on other debt. At times, arrears on such products have been a harbinger of trouble for mortgages. According to survey responses, households are banking on interest rates coming down further this year to avoid defaulting on debt.

As a result, the outlook for another year of healthy consumer spending growth is on shaky ground. Even before accounting for the potential impacts of a trade war, household spending is entering the year in a precarious position. No longer can retailers rely on surging population growth and households with cheap mortgages to drive revenues higher. But the Bank of Canada holds the key to avoiding a major slowdown in the economy. Cutting rates isn’t a silver bullet, but it’s probably the best hope for the economy this year.