Canadian Economy Shrinks 1.6% As Trade War Crushes Exports

The Canadian economy contracted for the first time in nearly two years as the trade war with the US 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 US dollar after the report, trading at C$1.3770 as of 8:35 a.m. in Ottawa. Canadian debt rallied across the curve, with the two-year yield falling to 2.66%.

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 constant changes to US 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.

At the same time, the report 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 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.

At the same time, 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 US — inventory investment rose about C$19 billion in the second quarter, the most since 2022, when the country’s firms were putting more wares aside amid snarled supply chains.

General government expenditure rose 5.1%. Investment in residential structures rose 6.3%.

Bank of Canada officials said they’re open to further rate reductions if the economy weakens and price pressures are contained. Their next decision is on Sept. 17.

Before the release, traders in overnight swaps put the odds off a rate cut at the next meeting at about 40%. The policy rate is 2.75%.

At around 5% to 7%, the effective tariff rate that the US 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 USMCA, the trade treaty between Canada, the US and Mexico that will be renegotiated in coming years.

Source: Bloomberg Europe