The trade war with the U.S. is starting to hurt the Canadian economy. The Canadian economy shrank in the second quarter much more than expected, as U.S. tariffs and a strong Canadian dollar hit exports.
How Are Tariffs Impacting the Canadian Economy?
Second-quarter gross domestic product (GDP) fell by 1.6% at an annualized rate. It was the first quarterly contraction in almost two years. Second-quarter GDP was expected to take a hit from U.S. tariffs; the question was: just how big would the decline be?
Economists were anticipating that the Canadian economy would contract by 0.5%. The second-quarter contraction was in line with Bank of Canada’s predictions, which pegged the Canadian economy as shrinking by approximately 1.5%.
For the first half of the year, Canada’s economy grew at an annualized rate of just 0.4%.
The second-quarter drop was led by a significant 26.8% annualized decline in exports as tariffs introduced by U.S. President Donald Trump took effect at the start of the quarter. It’s not all bad news: Bay Street economists believe that second-quarter GDP will mark the lowest point for the year.
That sentiment relies heavily on whether Canada can sign a trade deal with the U.S.
The Bank of Canada has laid out scenarios for the Canadian economy in the back half of 2025 and into 2026. If Ottawa can get Washington to pull back on some tariffs, or even keep them at current levels, the Canadian economy is expected to grow in the third quarter and into 2026.
How Will Q2 GDP Data Impact Interest Rates?
Should the trade war escalate, the Canadian economy could experience at least two consecutive quarters of negative growth. This would put the Canadian economy into a recession.
A greater-than-expected second-quarter slowdown coupled with weak momentum could force the Bank of Canada to resume interest-rate cuts when it meets again on September 17. The central bank has held interest rates steady at 2.75% for the last three consecutive meetings.
Financial markets have increased the odds of a 25-basis-point (0.25%) interest-rate cut in September to 50%. That’s up from 40% the day before the second-quarter GDP data were released.
That may not be enough to help the Canadian economy recover from U.S. tariffs or avoid a recession. Others believe that two 25-basis-point interest-rate cuts are needed this year. If this were to occur, it would take interest rates down to 2.0%.
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