The second quarter saw the biggest decline in Canada’s economy since the early months of the pandemic as a result of rising tariffs, a decline in exports, and a decline in business investment.
From April to June, trade-exposed sectors drove a monthly decline in economic activity. Debate over whether the Bank of Canada will resume lowering interest rates at its next policy meeting is fueled by early July data that suggests growth may remain elusive for the remainder of the year.
Canada’s economy contracts for second quarter in a row
Although the 1.4% quarterly decline was greater than the 0.7% contraction predicted by economists, it was more in line with the 1.5% decline that the Bank of Canada had predicted at its July meeting. At that point, the central bank had already maintained the stability of its benchmark rate. Additionally, industry-level GDP unexpectedly fell 0.1% in June, marking the third consecutive month-to-month decline, and Statistics Canada revised first-quarter growth downward from an earlier estimate of 2.2% to 2.0%. A flash estimate predicted a modest 0.1% rebound in July.
Bond yields fell after the release, signaling that investors now see a greater likelihood of a September rate cut. Money markets priced in almost a 50% chance of a cut, up from 40% before the GDP figures.
The second-quarter recession was the worst since the second quarter of 2020, when lockdowns reduced output by 37%, and the first to hit the GDP in seven quarters. The reversal of demand after companies front-loaded U.S. shipments earlier in the year, coupled with tariff hikes from the Trump administration, preceded the pullback. Weaker imports added 3.2 percentage points to GDP, partially offsetting the 9.8 percentage point drop in exports, which fell an annualized 26.8%.
Business investment also plummeted, with machinery and equipment spending falling by just over 10% annually, the biggest decline since 2016 before the pandemic. According to Royce Mendes, head of macroeconomic strategy at Desjardins, who still projects interest rate cuts in September and beyond, “the tariff war with the U.S. was terrible for the Canadian economy.”
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