The Q2 GDP release offered the first real look at how the Canadian economy is coping with tariffs. The economy contracted by 1.6 per cent quarter-over-quarter annualized – a steeper decline than market consensus, but just a hair below the Bank of Canada’s forecast of -1.5 per cent.
Net exports accounted for 8.1 percentage points of the drop, marking the largest decline outside of the pandemic period. Exports plunged 26.8 per cent, while imports slipped 5.1 per cent. Tariff uncertainty has also shaken business confidence, prompting firms to scale back their investments significantly. Non-residential investment fell by 10 per cent on an annualized basis, led by a 33 per cent drop in machinery and equipment spending – the fourth sharpest decline on record.
Households cushioned the impact during the quarter, supported by a pick up in residential construction and, above all, solid consumption growth (+4.5 per cent annualized). Still, it is unclear how long consumers can prop up the economy given sluggish growth in employee compensation, which drove a substantial reduction in the savings rate for a third consecutive quarter.
Meanwhile, June GDP was revised downward from 0.1 per cent to -0.1 per cent, and the weak rebound in July suggests economic weakness will persist into the third quarter.
The Bank of Canada’s July Monetary Policy Report (MPR) noted that several labour market indicators point to growing slack, though weakness appears concentrated in trade-sensitive sectors. Total employment fell by 32,500 in June, bringing the year-to-date decline to 47,000, according to Statistics Canada’s Survey of Employment, Payroll and Hours (SEPH), released a day before the GDP figures. Reflecting the current trade environment, the manufacturing sector shed 25,000 jobs, with losses concentrated in the two provinces most reliant on manufacturing: Ontario (-39,000) and Quebec (-24,000).
The key question is whether labour market weakness will spread beyond trade-sensitive sectors. At the press conference following the Bank’s most recent policy decision, Governor Tiff Macklem noted that “[i]f those spillovers are bigger and there is more downward pressure on inflation and the upward pressure from tariffs and trade disruption is contained, there may be a need to cut interest rates further.”
It is no surprise that the Canadian economy struggled in Q2. Arguably, the economy is evolving largely in line with the Bank’s July MPR forecast. Policymakers opted to stay on hold then, so this report is unlikely to push them any closer to a rate cut in September. August’s CPI and Labour Force Survey data will offer further clarity on the Bank’s next move.
Housing Affordability Watch
CMI monitors the latest developments and offers insights on solutions to Canada’s housing affordability crisis
How does monetary policy impact housing demand and affordability? Bank of Canada Governor Tiff Macklem says the 2026 framework review will examine this closely.
Our latest Housing Affordability Watch explores the role of mortgages in transmitting monetary policy, and why the Bank is expected to focus on financial stability rather than making affordability a direct policy goal.
Read it here: Monetary Policy and Housing Affordability: Avoiding the Boom-Bust Cycle
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