Canada’s economy stumbled more than expected in the second quarter of 2025, with new U.S. tariffs battering exports and discouraging business investment.
Statistics Canada reported on Friday that GDP fell at an annualized pace of 1.6 per cent, a sharper contraction than markets anticipated and a reminder of how vulnerable Canada remains to trade frictions with its largest partner.
Economists had been looking for a smaller pullback — about a 0.5 per cent annualized decline, according to BMO’s consensus forecast — though the Bank of Canada (BoC) itself had already penciled in something close to this outcome.
The immediate market reaction was swift: Bond yields fell, the Canadian dollar weakened, and traders began pricing in a higher chance of a rate cut.
Exports crumble under tariffs
The headline number was driven by steep declines in trade and business investment.
Exports tumbled 7.5 per cent, with auto shipments down 24.7 per cent, industrial machinery and equipment plunging 18.5 per cent, and travel services off 11.1 per cent. Machinery and equipment investment by firms also retreated.
“Simply put, the tariff war with the U.S. was terrible for the Canadian economy,” wrote Royce Mendes, economist at Desjardins Group.
June alone saw GDP contract by 0.1 per cent, weaker than expected. A preliminary “flash” estimate for July pointed to only a modest 0.1 per cent gain, underscoring that momentum heading into the third quarter remains fragile.
Economists divided on BoC’s next move
Whether the disappointing numbers will push the BoC into action at its September 17th decision is still up for debate.
CIBC’s Andrew Grantham said that while growth came in below market expectations, the results were “broadly in line” with the central bank’s July Monetary Policy Report.
Even so, he warned that June’s weakness means “momentum heading into Q3 [is] weaker than we or the Bank of Canada were likely expecting.” He continues to see “a couple more interest rate cuts” ahead, beginning as soon as September — unless the upcoming jobs report surprises to the upside.
Mendes of Desjardins also sees the release as supportive of a cut, pointing out that final domestic demand actually surged 3.5 per cent thanks to stronger household spending and housing.
That rebound, he argued, demonstrates “the domestic economy is not collapsing, even if overall output contracted.” He added that easing trade tensions with Washington have reduced risks of inflationary spillovers.
Others were less convinced. BMO’s Benjamin Reitzes said there was “nothing here screaming for a September cut,” emphasizing that robust domestic demand shows resilience.
Scotiabank’s Derek Holt went further, calling it a “policy mistake” to ease when areas like consumer spending and housing are “ripping higher,” noting domestic activity grew at a 3.4 per cent annualized pace.
Household spending keeps the engine running
Despite the drag from trade, households provided a bright spot. Consumer spending rose 1.1 per cent in Q2, led by purchases of vehicles, food, and financial services.
Housing investment also ticked up 1.5 per cent, thanks to new construction. Retail sales set a record in June with a 1.4 per cent gain.
TD economist Rishi Sondhi noted consumer spending grew at an impressive 4.5 per cent annualized pace, calling it a “massive contribution” to growth.
That outcome, he argued, lines up almost exactly with the BoC’s projections, suggesting policymakers could opt to hold rates in September.
Still, with wage growth slowing and slack building in the economy, Sondhi cautioned that “further downward pressure on inflation could pave the way for more rate cuts this year.”
Warning signs beneath the surface
Beneath the headline resilience, however, cracks are showing. Wages inched up just 0.2 per cent, the weakest growth since 2016 outside of pandemic quarters, according to Statistics Canada.
The household savings rate dropped to 5.0 per cent as spending outpaced income. On the fiscal side, government revenues were squeezed as excise taxes fell sharply following the removal of the federal carbon tax.
In short: Trade and investment are dragging the economy down, households are propping it up — but the balance is fragile.
Whether the BoC cuts rates in September or waits, the second quarter’s results confirm that the tariff war has left Canada on shakier ground.
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