Ottawa, Canada – August 29, 2025 – Canada’s economy likely contracted in the second quarter of 2025, marking a sharp slowdown from the robust 2.2% annualized growth in Q1 and intensifying the pressure on the Bank of Canada (BoC) as it approaches its September 17 rate decision. Preliminary data from Statistics Canada indicate a 0.1% annualized GDP increase for Q2, but economists largely expect a contraction of around 1.5% once final figures are confirmed, driven by a 25% drop in exports amid U.S. tariffs and the unwinding of pre-tariff stockpiling. This downturn, coupled with a softening labor market and persistent trade uncertainties, has heightened expectations for a rate cut, though sticky core inflation—rising to 3.05% in July—may temper the BoC’s hand. The policy rate has held at 2.75% since March, and while markets price in an 89% chance of a hold next month, a weakening economy could tip the scales toward easing to support growth without reigniting price pressures.
The Q2 contraction reflects the escalating U.S.-Canada trade war, with President Donald Trump’s tariffs—now at 25% on autos, 50% on steel and aluminum, and broader duties under Section 232—disrupting the integrated North American supply chain. Exports to the U.S., which account for 75% of Canada’s total, plunged 13.1% in Q2, reverting to 2021 levels and widening the current account deficit to a record C$21.16 billion. Business investment contracted, and household spending held steady but showed caution amid rising unemployment at 6.9% in June. Prime Minister Mark Carney’s countermeasures, including 25% retaliatory tariffs on $155 billion of U.S. goods (phased in from March), have provided some relief but also added to input costs, with firms absorbing 42% of tariff expenses to shield consumers.
Q2 GDP Breakdown: Exports and Trade Drag Growth
Statistics Canada’s advance estimate points to slim 0.1% Q2 growth, but the BoC’s own projection anticipates a 1.5% contraction, aligning with economist consensus for a downturn after Q1’s tariff-frontloading surge. Key drivers include:
- Exports Plunge: Goods exports fell 13.1%, with autos, energy, and metals hit hardest by U.S. duties, reversing Q1’s 10% spike from stockpiling. The merchandise trade surplus with the U.S. narrowed to $3.6 billion, the smallest since 2020.
- Domestic Demand Softens: Household consumption grew modestly (1.2% in Q1 pace), but business investment declined amid uncertainty, and residential construction weakened. Services held resilient, with retail up 6.1% year-over-year in Q1, but overall final domestic demand stagnated.
- Inflation Dynamics: Headline CPI eased to 1.7% in July, but core measures rose to 3.05%, with tariffs contributing to one-time price hikes offset by excess supply. Firms absorbed 42% of costs, delaying pass-through, but 40% plan hikes in the next year.
| Indicator | Q1 2025 (Annualized) | Q2 2025 Estimate (Annualized) | Key Driver |
|---|---|---|---|
| Real GDP Growth | +2.2% | -1.5% (BoC) / +0.1% (StatsCan prelim) | Export drop, trade uncertainty |
| Exports (Goods) | +10% (frontloading) | -13.1% | U.S. tariffs on autos, metals |
| Unemployment Rate | 6.4% (June) | 6.9% (projected) | Labor softening in trade sectors |
| CPI Inflation | 1.9% (June) | 1.7% (July) | Core up to 3.05%; tariff offsets |
Sources: Statistics Canada, BoC Monetary Policy Report
September Rate Decision: Cut or Hold Amid Uncertainty?
The BoC’s September 17 announcement—coinciding with its Monetary Policy Report—now faces a clouded path. Governor Tiff Macklem held at 2.75% on July 30, citing “balanced risks” but noting a weakening economy could warrant easing if trade disruptions are contained. Markets see an 89% chance of a hold, up from prior weeks, but 18 of 28 economists in a Reuters poll expect a 25 bp cut to 2.50%, with 60% forecasting at least two reductions by year-end.
- Arguments for a Cut: Q2 contraction, rising unemployment (to 7% projected), and excess supply signal disinflationary pressures, outweighing tariff-induced one-time inflation. TD Economics and National Bank predict cuts to 2.25% by year-end to support growth.
- Arguments for a Hold: Core inflation’s uptick and tariff “tailwinds” risk sustained pressures, per BoC scenarios. Scotiabank forecasts no cuts until 2026 if tariffs escalate. The loonie’s 4.5% YTD gain to C$1.377/USD cushions imports but hurts exports.
BoC projections show GDP rebounding to 1% in H2 2025 under current tariffs, with inflation near 2%, but escalation could prolong contraction and hike CPI. Carney’s de-escalation—dropping retaliatory tariffs on CUSMA goods by September 1—may aid talks, but uncertainty persists ahead of 2026 USMCA renegotiations.
Broader Implications: Recession Risks and Policy Responses
The contraction risks a recession if Q3 follows suit, with unemployment potentially hitting 7.5% and GDP growth at 1.25% for 2025 (down from 1.7%). Tariffs equate to a $1,300 household tax, squeezing margins (42% absorbed by firms) and delaying inflation pass-through. Carney’s $2 billion Strategic Response Fund and provincial measures (e.g., Alberta’s liquor bans) aim to mitigate, but interprovincial barriers removal could offset 4.4–7.9% GDP hit.
As September nears, the BoC’s decision hinges on August data: inflation (due September 17) and jobs. A cut could stabilize growth; a hold risks deeper slowdown. With tariffs’ “uncertainty tax” weighing, Canada’s resilience—via CUSMA exemptions and diversification—will be tested.