Canada’s Economy Contracts 0.4% Amid U.S. Tariffs Impact

The Canadian economy faced a significant setback in the second quarter of 2025, with real gross domestic product (GDP) contracting by 0.4 percent. This decline marks a sharp contrast to the 0.5 percent growth recorded in the first quarter, according to data from Statistics Canada. The downturn was largely attributed to the adverse effects of tariffs imposed by the United States, which hampered trade and stifled business investment.

Trade figures reflected the severity of the situation, with exports plummeting by 7.5 percent in the second quarter, following a modest increase of 1.4 percent in the previous quarter. The automotive sector experienced the most significant impact, as exports of passenger cars and light trucks fell by 24.7 percent. Other sectors, including industrial machinery and travel services, also witnessed double-digit declines.

Imports from the U.S. declined by 1.3 percent, as both businesses and consumers began to reassess their purchasing decisions in light of retaliatory tariffs. Furthermore, trade disruptions contributed to a 9.4 percent contraction in business investment in machinery and equipment. Statistics Canada highlighted that this was the slowest pace of investment in this area since the end of 2016, excluding the initial year of the COVID-19 pandemic.

Despite these challenges, there were some positive developments within the economy. Household spending increased by 1.1 percent, driven primarily by a substantial 5.6 percent rise in purchases of new trucks, vans, and sport utility vehicles. Government spending also increased, alongside a notable rise in business inventories, which helped to somewhat mitigate the GDP decline.

The housing market emerged as a key indicator of domestic strength, with residential investment rising by 1.5 percent. British Columbia stood out for its relatively robust construction sector, particularly in apartment developments, which helped balance weaknesses in renovations and resale activities.

Worker compensation saw a modest increase of 0.2 percent in the second quarter, the smallest rise since the second quarter of 2016, excluding the pandemic year. Wages and salaries in federal public administration increased by 2.5 percent, while the mining and oil and gas extraction sectors saw a growth of 2.9 percent. However, the slow growth in wages led to a decrease in the household saving rate, which fell to 5 percent from 6 percent in the previous quarter.

Household property income increased by 0.9 percent, with gains in foreign investment and dividend income offsetting declines in interest earned from deposits and securities. Mortgage and non-mortgage interest expenses edged up by 0.1 percent as the Bank of Canada maintained its policy interest rate.

The federal government reported a sharp decline in revenue, dropping by 4.2 percent in the second quarter, primarily due to the removal of the federal consumer carbon tax on April 1, 2025. Federal spending rose by 1.8 percent, driven by increased wages, purchases of goods and services, and financial support for Canada Post amid its ongoing challenges. Consequently, the federal government’s net borrowing accelerated during this period.

This economic data arrives shortly after U.S. President Donald Trump raised tariffs on goods not compliant with the Canada–United States–Mexico Agreement (CUSMA) from 25 percent to 35 percent. This move prompted many Canadian companies to scramble for compliance under the trade deal. Before the August 1 tariff hike, it was estimated that around 86 percent of Canadian exports to the U.S. would eventually meet compliance standards and cross the border duty-free. However, at that time, less than half of those goods had received certification, according to a research note from RBC economist Salim Zanzana.

Looking ahead, the Bank of Canada’s latest Monetary Policy Report forecasts that Canada’s economic growth will be modest at 1 percent in the second half of 2025, with growth projected to rise to 1.8 percent by 2027 as the effects of trade policy uncertainty diminish and global demand increases. In a policy note, TD economist Rishi Sondhi remarked that while the impact of U.S. tariffs was anticipated, domestic demand has shown resilience, particularly evident through a strong surge in consumer spending.

“Today’s GDP data fell in almost exactly in line with what the Bank of Canada expected in their latest forecast. However, domestic demand looks to have surprised on the upside,” wrote Sondhi. He added that this resilience could exert further downward pressure on inflation and potentially lead to more interest rate cuts later in the year.