Canadian economy shrinks 1.6% in 2nd quarter as U.S. tariffs squeeze exports

Canada's economic system shrank in the endorse canton by a often larger level than expected as U.S. Tariffs squeezed exports, but higher household and government spending cushioned some of the impact, Statistics Canada said on Friday.

The GDP for the quarter that ended June 30 slowed by 1.6 per cent on an annualized basis, while first-quarter growth was downwardly revised to two per cent, the data agency said.

The latest figures show that Canada's economy grew at an annualized rate of 0.4 per cent in the first six months of the year. The second quarter contraction was the first quarterly slowdown in seven quarters.

A larger-than-expected slowdown in growth could boost chances of an interest rate cut by the Bank of Canada in September. The central bank has kept rates steady at 2.75 per cent at its last three meetings.

The Bank of Canada predicted in its July report on monetary policy that the Canadian economy would contract somewhere in the ballpark of 1.5 per cent during the second quarter.

Money markets predicted a 48 per cent chance of a rate cut on Sept. 17 once GDP figures were released — up from 40 per cent before they were published.

Statistics Canada said the economy contracted by 0.1 per cent in June on a monthly basis, mainly led by a decline in output from goods-producing industries, which accounts for a quarter of the country's GDP.

Economists polled by Reuters were expecting second-quarter GDP to contract by 0.6 per cent and the June monthly GDP to expand by 0.1 per cent.

"That weaker than expected trend in the monthly figures makes today's release supportive for our forecast of a September interest rate cut, although upcoming employment and [inflation] data will still be important for that call," wrote Andrew Grantham, a senior economist at CIBC Capital Markets.

Exports, mainly responsible for sinking the economy in the second quarter, declined 7.5 per cent during that period — the biggest drop in five years, according to Statistics Canada.

Business investment in machinery and equipment also shrank for the first time since the pandemic, with investments falling 0.6 per cent in the second quarter.

Domestic demand, however, grew by 3.5 per cent, indicating health in the domestic economy.

The boost came from household spending, which jumped by 4.5 per cent on an annualized basis, residential investments — which rose 6.3 per cent — and government spending on goods and services, which surged by 5.1 per cent, Statscan noted.

"It should come as no surprise that the Canadian economy struggled in Q2 as tariffs ramped up. However, the domestic strength is somewhat comforting, although the sustainability of that momentum is an open question," wrote Benjamin Reitzes, a macrostrategist and managing director of Canadian rates at the Bank of Montreal.

The economy is evolving "largely in line" with the Bank of Canada's forecast from July, he added.

Central bank officials opted to hold rates at their last meeting, and Reitzes predicted that the GDP report likely won't push them any closer to cutting in September, especially with more employment and inflation data to come.

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