Transport trucks carry cargo containers at Vancouver's port. GDP data today were in line with the Bank of Canada’s projection but considerably worse than Bay Street analysts were anticipating.DARRYL DYCK/The Canadian Press
The Canadian economy contracted sharply in the second quarter as trade tensions with the United States hammered exports and weighed on business investment.
Real gross domestic product declined 1.6 per cent at an annualized rate, the first quarterly contraction in nearly two years, Statistics Canada reported on Friday.
The result was in line with the Bank of Canada’s projection but considerably worse than Bay Street analysts were anticipating. A Reuters poll ahead of the data expected a 0.6-per-cent decline.
Financial markets increased their bets on another interest rate cut from the central bank next month after the report. Interest rate swap markets are pricing a 50-per-cent chance of a quarter-point rate cut on Sept. 17, up from 40-per-cent a day before, according to LSEG data.
The downturn in the second quarter was led by a massive 26.8-per-cent annualized drop in exports as U.S. President Donald Trump’s levies began to bite and tariff front-running in the first quarter went into reverse. Automobile and industrial machinery exports were hit particularly hard. Imports declined 5.1 per cent.
The uncertainty created by the trade war also weighed on business investment, which fell at an annualized pace of 10.1 per cent in the second quarter, the worst result since 2016, outside of the COVID-19 pandemic.
The data provide the clearest picture yet of the impact Mr. Trump’s barrage of tariffs is having on Canada’s export-oriented economy.
Since the spring, the president has imposed a blanket tariff on Canadian goods, with a carveout for products that comply with continental free trade pact (United States–Mexico–Canada Agreement) rules, as well as steep sectoral tariffs on steel, aluminum, automobiles and more recently, copper. This has hit Canada’s manufacturing sector disproportionately.
On a monthly basis, GDP contracted 0.1 per cent in June led by a drop in auto, wood product, primary metals and machinery manufacturing.
Canada’s tariff revenue surges – but nowhere close to Ottawa’s projections
A flash estimate for July showed a slight rebound, with advanced estimates suggesting GDP grew 0.1 per cent that month. But that was weaker than analysts anticipated.
“The second quarter was always expected to be negative given the slump seen in exports, the only question remaining was the magnitude of the decline,” Andrew Grantham, senior economist at Canadian Imperial Bank of Commerce, wrote in a note to clients.
“Because of that the main news in today’s release is actually how weak momentum still was towards the end of the quarter and into the start of Q3, even as exports had begun to stabilize,” he said.
The drop in exports and business investment in the quarter was partially offset by a build-up of inventories, possibly in anticipation of easing trade tensions.
There was also a notable rebound in household spending, particularly on new trucks and SUVs as well as financial services and food and beverage services. Residential investment also increased.
“It wasn’t all bad news,” Benjamin Reitzes, managing director of Canadian rates at Bank of Montreal, wrote in a note to clients. “Final domestic demand rose 3.5 per cent annualized, reflecting the resilience and perhaps Canadians’ bias to buy/travel domestically. However, income growth was up just 0.7 per cent … which could hamper consumers’ ability to continue their spending ways.”
Economists on Bay Street and at the Bank of Canada expect the second quarter to be the low point of 2025.
Canada’s tariff revenue surges – but nowhere close to Ottawa’s projections
To a large degree, the fall in exports was the mirror image of a surge in cross-border shipments in the first quarter, as companies rushed to get ahead of U.S. tariffs. That see-saw dynamic should moderate in the coming months.
A lot, however, depends on the trajectory of the trade war and whether Canada can secure some relief from Mr. Trump’s tariffs.
Ottawa and Washington failed to reach an agreement by Mr. Trump’s Aug. 1 deadline, but the two sides have started to re-engage after Prime Minister Mark Carney dropped retaliatory tariffs against many U.S. goods last week.
“The good news is that trade tensions between Canada and the US have been easing. With most goods passing the border USMCA compliant, the exemptions from both Canada and the US are meaningful,” Royce Mendes, head of macro strategy at Desjardins, wrote in a note to clients.
He said that the “tail risks to the Canadian economy have diminished significantly” while the reduction in retaliatory tariffs last week means concerns about tariff-induced inflation have declined.
“That said, the Canadian economy is still far from firing on all cylinders,” Mr. Mendes wrote.
In July, the Bank of Canada outlined three possible scenarios for the Canadian economy through the back half of the year and into 2026.
If Ottawa can get Washington to ease some tariffs, or even maintain them at the current levels, the Canadian economy should begin to grow again slowly in the third quarter and through into next year, the BoC said.
But if the trade war escalates, Canada could be in for two more quarters of negative growth, putting the country in a recession.