Canada Q2 growth shrinks for first time in 2 years as U.S. tariffs bite — is a recession ahead or can household spending bring relief?

Canada’s economy hit an unexpected setback in the second quarter of 2025, shrinking by more than economists had forecast. The headline GDP contraction was driven largely by U.S. tariffs that hammered exports, even as domestic demand, housing, and household spending showed surprising resilience.

The split picture is now fueling debate over whether the Bank of Canada should move toward interest rate cuts in September.

How deep was Canada’s economic slowdown in Q2?

Statistics Canada reported that real GDP fell 0.4% in the second quarter, on an annualized basis, reversing a 0.5% gain in the first quarter.

On a per-capita basis, GDP also slipped 0.4% — an important marker given Canada’s rapid population growth in recent years.

The contraction was sharper than economists had anticipated. Exports of goods dropped 7.5%, led by a staggering 24.7% plunge in passenger cars and light trucks — a direct casualty of tariffs imposed by the United States. Industrial machinery exports fell 18.5%, while travel services slid 11.1%.

Despite the weakness abroad, the domestic economy expanded. Final domestic demand — a measure of household, government, and business spending — rose 0.9%, with consumer spending up 1.1% and residential construction advancing 1.5%.

Why are U.S. tariffs such a heavy drag?

The trade hit is unmistakable. The United States remains Canada’s largest trading partner, and Washington’s tariffs on autos, machinery, and select industrial products are already biting into output.

The result has been a sharp deterioration in export volumes and prices.

Export and import prices both fell in Q2, but the drop was larger for exports, dragging Canada’s terms of trade down 1.1%.

Canada responded with counter-tariffs, and that too reshaped trade patterns. Imports declined 1.3%, with notable drops in passenger vehicles (-9.2%) and travel services (-8.5%).

However, imports of intermediate metals — especially unwrought gold, silver, and platinum group metals — surged more than 35%, reflecting both industrial demand and investor appetite for safe-haven assets.

What about business investment?

The investment picture was mixed. Overall business investment fell 0.6%, weighed down by a 9.4% collapse in machinery and equipment spending — the weakest since 2016 outside of the pandemic shock.

Investment in non-residential buildings also slipped 3.3%, underscoring the toll tariffs and trade uncertainty are taking on corporate decision-making. One bright spot: engineering structures rose 3.6%, thanks to the arrival of a high-value oil project module off Newfoundland.

Inventories, however, were a striking contributor. Businesses accumulated $30.1 billion in inventories in Q2, nearly triple the pace of Q1. That included large stockpiles in manufacturing, wholesale trade, and precious metals holdings by investors.

How are households holding up?

Households remain the stabilizing force in the economy. Consumer spending rose 1.1%, led by demand for new trucks, vans, and SUVs (+5.6%). Canadians also spent more on insurance and financial services (+1.3%), food (+0.9%), and dining out (+0.9%).

Not all categories saw gains. Spending on electricity dropped 3.2%, while purchases of alcoholic beverages slid 3.9%. But overall, per-capita consumption grew at the fastest pace in a year.

The housing sector also staged a modest rebound. Residential investment grew 1.5%, powered by a 3.7% jump in new construction. This was a key offset to declines in exports and business machinery investment.

What do economists say about the mixed data?

Economists are split on what this means for the Bank of Canada’s next move.

Jimmy Jean, chief economist at Desjardins Group, noted the weakness was largely “uniquely focused on exports,” and not yet a sign of broad recession. He argued the combination of weaker trade, a recent inflation surprise, and easing tariff tensions make “a pretty strong case to resume cutting rates in September.”

By contrast, Derek Holt, vice president of capital markets economics at Scotiabank, emphasized the strength in domestic demand, which grew at a 3.4% annualized pace. He warned that cutting rates into this resilience “would be premature,” and argued that the Bank of Canada should wait for jobs and CPI data before making a decision.

What does this mean for households and markets?

For Canadians, the mixed GDP picture means uncertainty. On one hand, the sharp export slump reflects vulnerability to U.S. trade policies — a risk that could intensify if tariffs broaden. On the other, the resilience of consumer spending and housing suggests the domestic economy still has momentum, supported by steady job growth and government spending.

Financial markets are now sharply focused on two things:

• The September Bank of Canada rate decision, where traders are split between expecting a 25-basis-point cut or a hold.
  
  
• Upcoming inflation and jobs data, which could tip the balance.
  
  

For households, the key implication is borrowing costs. If rate cuts come, mortgages and loans may ease slightly. If not, higher-for-longer interest rates will continue to squeeze household budgets even as inflation remains stubborn in some categories.

FAQs

Q1: Why did Canada’s economy shrink in Q2 2025?
Because U.S. tariffs sharply reduced exports of cars, machinery, and travel services.

Q2: Will the Bank of Canada cut interest rates after the Q2 2025 GDP report?
Markets expect a possible rate cut in September, but the decision depends on jobs and inflation data.