Canadian economy shrinks 1.6% as trade war crushes exports
By Erik Hertzberg
(Bloomberg) — The Canadian economy contracted for the first time in nearly two years as the trade war with the U.S. pinched exports and business investment.
Canada’s gross domestic product shrank at a 1.6% annualized pace in the second quarter, Statistics Canada reported Friday from Ottawa. That’s the biggest decline since the Covid-19 pandemic and the first contraction in nearly two years.
While roughly in line with the Bank of Canada’s forecasts, it’s a worse print than was expected in a Bloomberg survey of economists, which had forecast a 0.7% decline.
The loonie tumbled to a session low versus the U.S. dollar after the report and traded at $1.3761 as of 9:56 a.m. in Ottawa. Canadian debt rallied across the curve, with the two-year yield falling to 2.66%.
Traders in overnight swaps upped bets for a cut at the central bank’s next meeting on Sept. 17, putting the odds near a coin flip, from about 40% before the release. Policymakers have said they’re open to further easing if the economy continues to slow and inflation pressures are contained. There are still major data releases before that decision, including key employment and inflation prints.
Exports fell 27% on an annualized basis as US tariffs on Canadian goods shattered the country’s shipments abroad. That more than reversed a temporary first-quarter boost in trade activity that was driven by shippers trying to front-run President Donald Trump’s tariff barrage. Imports declined 5.1%.
Business investment contracted 10.1% after rising just 1.1% in the first quarter, highlighting the mounting pessimism facing Canadian firms as they contend with the uncertain and frequent changes to U.S. levies and policy.
The data capture the severe damage inflicted by the trade war, which started earlier in 2025 as Trump threatened and then imposed tariffs on imports of many Canadian products, including on steel, aluminum, autos and other goods. The US is Canada’s largest trading partner.
The report reverses 2% GDP growth in the first quarter. At the same time, it shows some evidence that the trade damage isn’t rapidly creeping through the broader economy.
On a monthly basis, preliminary industry-level data suggests Canada’s economy expanded 0.1% in July, after unexpectedly contracting 0.1% in June, the statistics agency said.
There are also some signs of strength in final domestic demand, which rose 3.5% in the second quarter, driven by a 4.5% increase in household consumption — an acceleration despite a major slowdown in population growth.
Still, the resilience of households is likely to be tested in coming months. Disposable income rose just 1.3% in the three months between April and June, the weakest growth in more than two years, likely reflecting persistent looseness in the country’s labor market.
The data also show Canadian firms are still adding to their stockpiles despite the subdued export demand from the U.S. — inventory investment rose about $19 billion in the second quarter, the most since 2022, when the country’s firms were putting more wares aside amid snarled supply chains.
Arguably, the economy is evolving largely in line with the Bank of Canada’s July monetary policy report forecast, Benjamin Reitzes, rates and macro strategist at Bank of Montreal, said in a report to investors.
“Policymakers opted to stay on hold then, so this report likely doesn’t push them any closer to cutting in September, with the labour force survey and CPI still to come,” he said.
The contraction implies that economic slack built in the second quarter, and even with a better performance in the third quarter likely on tap, the economy probably remains in excess supply, said Rishi Sondhi, economist at Toronto Dominion Bank.
“This points to further downward pressure on inflation and could pave the way for more rate cuts this year,” he told investors in a report. That’s especially true given the policy rate, at 2.75%, is “only at the mid-point of what the bank considers neutral for the economy.”
In the second quarter, general government expenditures rose 5.1%. Investment in residential structures rose 6.3% as housing starts strengthened and the country’s real estate market showed signs of recovery.
At around 5% to 7%, the effective tariff rate that the U.S. imposes on imports of Canadian goods remains among the lowest in the world. That’s because of a carve-out for goods that cross the border under the U.S.-Mexico-Canada Agreement, the trade treaty between the North American nations.
–With assistance from Mario Baker Ramirez and Carter Johnson.
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Last modified: August 29, 2025