A railway grain terminal in Alberta. (Photo by: LJM Photo/Design Pics Editorial/Universal Images Group via Getty Images) · Design Pics Editorial via Getty Images
Canada’s economy shrank 1.6 per cent on an annualized basis in the second quarter of 2025, Statistics Canada said on Friday, as U.S. tariffs pummelled exports and business investment fell sharply. The decline was steeper than economists had expected but roughly in line with the Bank of Canada’s (BoC’s) forecast.
Markets quickly reacted, with Canadian bond yields slipping and the loonie weakening as investors priced in a greater chance of a rate cut, according to CIBC Economics. StatCan also revised first-quarter growth down to two per cent from 2.2 per cent.
Analysts had expected a 0.5 per cent annualized decline in GDP, according to consensus estimates from BMO. Economists were split on what Friday’s results mean for the Bank of Canada’s September 17 announcement. Some pointed to the weak momentum into the third quarter as reason to cut, while others stressed the outcome was broadly in line with the central bank’s own forecast — and at least one argued that strength in consumer spending and housing shows the case for holding rates.
Newly imposed U.S. tariffs choked off exports in the second quarter, Statistics Canada said, and businesses also invested less in machinery and equipment. Exports dropped 7.5 per cent, with passenger car and light truck exports down 24.7 per cent and industrial machinery, equipment and parts down 18.5 per cent. Travel services also fell 11.1 per cent.
“Simply put, the tariff war with the U.S. was terrible for the Canadian economy,” Desjardins Group economist Royce Mendes wrote in a note.
Real GDP contracted 0.1 per cent in June from the previous month, also weaker than expected. The flash estimate for July, Statistics Canada’s projection based on preliminary data, showed a modest 0.1 per cent increase.
For the BoC, there’s nothing here screaming for a September cut, though it will certainly keep the chatter around further easing intact.BMO economist Benjamin Reitzes
CIBC economist Andrew Grantham noted that, though below consensus, the second-quarter slowdown was “broadly in line” with the BoC’s forecasts in its July Monetary Policy Report. Even with July’s flash estimate showing improvement, June’s GDP contraction “leaves momentum heading into Q3 weaker than we or the Bank of Canada were likely expecting,” he writes.
“We continue to think that a couple more interest rate cuts from the Bank of Canada are needed to accelerate the recovery,” Grantham writes, with the first one in September, unless jobs data due on September 5 is surprisingly strong.
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Desjardins’ Mendes emphasized that final domestic demand jumped 3.5 per cent in the quarter, driven by stronger household spending and housing. That rebound followed weakness in the first quarter, and Mendes said it shows “the domestic economy is not collapsing, even if overall output contracted.” He noted that easing trade tensions with the U.S. “have diminished tail risks” for Canada, while also reducing concerns about tariff-driven inflation at the Bank of Canada. He also argued that the softer monthly momentum makes the release “supportive for our forecast of a September interest rate cut.”
Not all economists believe the second-quarter data will push policymakers toward a cut. “For the BoC, there’s nothing here screaming for a September cut, though it will certainly keep the chatter around further easing intact,” BMO economist Benjamin Reitzes said, adding that the strength in domestic demand highlights the economy’s resilience.
TD economist Rishi Sondhi stressed that consumer spending made a “massive contribution” to growth in the quarter, rising at a 4.5 per cent annualized pace. He said the data “fell almost exactly in line with what the Bank of Canada expected in their latest forecast,” suggesting the BoC may choose to hold rates steady in September. But with wage growth slowing and economic slack building, Sondhi added that “further downward pressure on inflation could pave the way for more rate cuts this year.”
Scotiabank’s Derek Holt took a more hawkish view, arguing the headline contraction masked an economy that “ripped higher” in areas like consumer spending and housing, with overall domestic activity rising 3.4 per cent at an annualized pace.
“Easing on the back of strong final domestic demand would be a policy mistake,” Holt wrote, pointing to surging consumer spending and housing as evidence the effects of past cuts are still working through the system.
While trade and investment were the main factors slowing the economy, household demand provided an offset. Household spending rose 1.1 per cent in the quarter, led by purchases of trucks, vans and SUVs, insurance and financial services, and food. Housing investment also turned positive, with new construction driving a 1.5 per cent gain. Retail trade hit a record high in June, rising 1.4 per cent.
However, underlying momentum was mixed. Wage growth was anemic at just 0.2 per cent — “the smallest increase since the second quarter of 2016” outside of the pandemic, Statistics Canada says — and the household saving rate fell to 5.0 per cent as spending grew faster than incomes. Federal finances also weakened “as excise taxes fell sharply following the removal of the federal consumer carbon tax.”
John MacFarlane is a senior reporter at Yahoo Finance Canada. Follow him on X @jmacf.
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