Canada’s economy slowed sharply in the second quarter of 2025, marking its weakest performance in several years. Statistics Canada confirmed that real GDP contracted at an annualized rate of 1.6%, a far steeper drop than most forecasts anticipated. This decline signals that trade pressures and weakening investment are weighing heavily on overall growth.
The contraction was driven largely by a steep fall in exports, which dropped 7.5% during the quarter, the largest decline in five years. Business investment also slipped, while goods-producing industries posted notable losses. At the same time, stronger household and government spending provided some offset, highlighting a divide between domestic demand and external trade performance.
This downturn has already intensified discussions about the Bank of Canada’s next steps on interest rates and inflation management. With momentum weakening heading into the third quarter, policymakers and businesses alike are watching closely to determine whether this slowdown marks a temporary setback or the start of broader economic challenges. For more details on the contraction and its underlying causes, see the full report from CBC News on Canada’s Q2 GDP.
Canada’s economy contracted sharply in the second quarter of 2025, reflecting the impact of U.S. tariffs, weaker exports, and softer business investment. At the same time, household and government spending provided some offset, preventing an even steeper downturn.
Overview of the 1.6% Contraction
Real gross domestic product (GDP) fell at an annualized rate of 1.6% in Q2 2025, according to Statistics Canada. This marks the first quarterly decline in nearly two years.
The contraction was driven largely by a 7.5% drop in exports, with passenger vehicles and industrial machinery among the hardest hit categories. U.S.-imposed tariffs significantly reduced trade flows, while Canadian countermeasures also dampened imports.
Business investment weakened, particularly in machinery and equipment, which recorded a 9.4% decline. Residential construction rose modestly, but it was not enough to offset broader investment losses.
Household spending increased by 1.1%, supported by higher purchases of trucks and SUVs, as well as growth in financial services and food expenditures. However, weaker wage growth and a falling household saving rate highlighted underlying financial pressures.
Comparison to Previous Quarters
The second-quarter decline followed a 2.0% annualized expansion in Q1 2025, which was revised downward from earlier estimates. The reversal underscores how quickly external trade pressures reshaped Canada’s economic trajectory.
On a quarterly basis, real GDP fell 0.4%, reversing the 0.5% gain in the first quarter. While domestic demand improved, it was outweighed by the sharp contraction in exports.
| Quarter | Real GDP (q/q change) | Annualized Rate | Key Drivers |
|---|---|---|---|
| Q1 2025 | +0.5% | +2.0% | Household spending, inventory buildup |
| Q2 2025 | -0.4% | -1.6% | Export decline, weaker investment |
The divergence between stronger domestic demand and weaker external trade highlights the uneven nature of Canada’s current economic performance.
Historical Context: Worst Performance in Years
The 1.6% annualized contraction represents the steepest quarterly GDP decline since Q2 2020, when the pandemic caused a severe downturn. Outside of that exceptional period, it is the weakest result in nearly a decade.
Economists note that this downturn is directly tied to trade disruptions rather than a broad collapse in domestic activity. Exports of autos, machinery, and travel services were among the most severely affected categories.
Compared to past trade-related slowdowns, the scale of the Q2 2025 decline is notable. Analysts at Global News and Reuters highlight that the contraction is the sharpest since Canada’s recovery from COVID-19 began, underscoring the vulnerability of the economy to U.S. tariffs.
While household and government spending provided some resilience, the weakness in exports and investment signalled a significant setback, marking this period as one of the most challenging since 2020.
Major Factors Behind the Economic Downturn
The contraction reflected a mix of external pressures and domestic weaknesses. Trade tensions with the United States, weaker export performance, and reduced business investment each played a significant role in pulling growth into negative territory.
Impact of U.S. Tariffs and Trade War
The U.S. administration under Trump escalated tariff measures on Canadian goods, including steel, aluminium, autos, and energy products. These actions disrupted integrated supply chains and raised costs for Canadian manufacturers. In response, Canada imposed counter-tariffs on billions of dollars of U.S. imports, further straining cross-border trade.
The Bank of Canada highlighted that the trade conflict created high uncertainty for businesses, leading many to delay hiring and capital spending. The uncertainty also affected consumer confidence, prompting households to reduce discretionary spending.
Tariffs particularly hit trade-exposed sectors such as automotive manufacturing, metals, and energy. For example, U.S. tariffs on steel and aluminium directly reduced Canadian export volumes, while retaliatory Canadian tariffs raised input costs for domestic firms relying on U.S. imports.
Drop in Canadian Exports
Canadian exports fell sharply as tariff threats disrupted normal trade flows. Merchandise exports to the U.S. initially surged as firms rushed to ship goods before higher tariffs came into effect. However, shipments later contracted, with exports of motor vehicles and parts dropping after reaching a temporary peak.
According to Statistics Canada, exports to the U.S. pulled back by more than 6% in March 2025 after earlier gains. This reversal weakened Canada’s merchandise trade surplus, which narrowed from $13.8 billion in January to $8.4 billion in March.
Sectors most dependent on U.S. demand—such as autos, machinery, and energy—faced the steepest declines. The pullback underscored Canada’s reliance on the U.S. market, where exports account for nearly 17% of GDP and support millions of jobs.
Business Investment Slowdown
Business investment weakened as firms faced higher costs and growing uncertainty. Investment in machinery and equipment, a key driver of long-term productivity, declined as companies postponed or cancelled projects. This trend reflected both tariff-related risks and Canada’s longer-standing productivity challenges.
The OECD noted that high household debt and affordability pressures also weighed on the outlook, reducing domestic demand and discouraging expansion. With non-residential investment still below pre-pandemic levels, Canadian businesses struggled to build competitiveness.
Trade-exposed sectors, particularly manufacturing and construction, were most affected. Firms reliant on U.S. intermediate goods faced higher costs, while exporters delayed capacity expansion until trade conditions stabilized. This slowdown in capital spending limited Canada’s ability to offset the external shock from tariffs.
Sectoral Analysis: Industries Most Affected
The contraction in Canada’s economy during the second quarter was driven by sharp declines in trade-sensitive industries and regional manufacturing hubs. Export-heavy sectors faced the steepest losses, while household spending offered only limited resilience.
Manufacturing Sector Performance
The manufacturing sector absorbed the most direct hit from U.S. tariffs. Exports of automobiles and industrial machinery fell sharply, with vehicle shipments down by double digits. According to Statistics Canada, overall exports dropped 26.8% on an annualized basis, the steepest quarterly decline in years, which directly weakened factory output and employment.
Steel, aluminium, and copper producers also reported weaker demand. Tariffs raised costs for Canadian exporters while making their products less competitive abroad. Imports declined as well, falling 5.1%, which reflected lower demand for foreign components used in Canadian production.
Monthly data showed that June was particularly weak. Output in auto, wood products, primary metals, and machinery manufacturing all contracted. This pattern highlights the vulnerability of Canada’s export-oriented industries to sudden policy shocks such as tariffs.
Ontario and Regional Impacts
Ontario, as the core of Canada’s automotive and machinery production, felt the brunt of the downturn. Auto assembly plants in Southern Ontario reduced shifts, and parts suppliers cut back on hours. This ripple effect strained regional employment and slowed wage growth in communities reliant on factory jobs.
Other provinces with resource-linked manufacturing also struggled. British Columbia’s wood product manufacturers faced weaker demand, while Quebec’s aerospace sector saw delays in orders. These regional pressures compounded the national contraction.
The uneven impact underscores how trade disputes disproportionately affect provinces tied to manufacturing supply chains. In contrast, resource-heavy provinces like Alberta faced less immediate tariff exposure but still saw weaker investment confidence.
Services and Consumer Spending Trends
Despite the weakness in manufacturing, household spending provided some stability. Canadians increased purchases of new trucks and SUVs, along with higher spending on food, beverages, and financial services. Residential investment also picked up, helping offset part of the export decline.
Final domestic demand rose 3.5% annualized, showing resilience in services and retail activity. However, income growth was limited at just 0.7%, raising concerns about the sustainability of consumer-driven growth.
The services sector’s relative strength highlights an important contrast. While goods-producing industries contracted, domestic-oriented sectors like retail, hospitality, and financial services continued to expand, albeit at a modest pace. This helped prevent an even deeper decline in overall GDP.
For more detail, Statistics Canada’s report on the Canadian economy contraction outlines the industries most affected by the second-quarter downturn.
Reactions from Experts and Financial Institutions
The sharp 1.6% contraction in Canada’s second-quarter GDP has prompted careful analysis from economists and financial institutions. While some see the weakness as concentrated in trade-exposed sectors, others stress that domestic demand has shown resilience, softening concerns about an immediate recession.
Insights from Economists and Analysts
Economists noted that the contraction was largely driven by a steep drop in exports following the imposition of U.S. tariffs. Andrew Grantham of CIBC pointed out that while headline growth was negative, household consumption and housing activity remained firm, suggesting underlying domestic demand is still intact.
Benjamin Reitzes of BMO emphasized that the decline, though significant, should not be misread as the beginning of a prolonged downturn. He highlighted that much of the weakness stemmed from temporary factors such as wildfire disruptions and tariff-related trade adjustments.
Analysts also noted that advance estimates for July GDP showed a slight rebound. This aligns with early data indicating stronger retail sales and modest recoveries in manufacturing and wholesale activity, offering a more balanced view of the economic trajectory.
Bank of Canada’s Perspective
The Bank of Canada acknowledged the contraction but framed it within the context of global trade tensions. According to its recent outlook, a protracted conflict with the U.S. could permanently reduce Canada’s GDP level if tariffs remain elevated.
At the same time, the Bank stressed that most Canadian exports continue to move duty-free under CUSMA provisions. This limits the downside compared to other U.S. trade partners. Policymakers view this as a key buffer against further shocks.
The Bank’s governing council remains cautious. While it recognises that growth is slowing, it has not signalled an urgent need for rate cuts, instead focusing on inflation trends and the resilience of consumer spending as stabilising factors.
Commentary from BMO, CIBC, and RBC
BMO’s Benjamin Reitzes argued that the contraction should be viewed as a short-term adjustment rather than a structural weakness. He underscored that domestic demand indicators remain broadly stable.
CIBC’s Andrew Grantham highlighted that the data supports a “soft landing” scenario. He noted that housing and consumer spending are offsetting weakness in exports, reducing the likelihood of a deeper recession.
RBC economists pointed to early signs of recovery in July, with GDP edging up 0.2%. They stressed that while growth will remain slow, the economy is tracking toward modest positive expansion in the third quarter, rather than repeating the second quarter’s contraction.
For example, RBC’s analysis showed that manufacturing output rose 0.7% and mining rebounded 1.4% in July, helping to stabilise overall activity. This suggests that the downturn in Q2 may already be easing as temporary disruptions fade (RBC).
Monetary Policy, Inflation, and Interest Rates
Canada’s economy is facing slower growth, with weaker exports and softening domestic demand. Monetary policy decisions, inflation dynamics, and changes in interest rates are shaping the outlook for both households and businesses.
Bank of Canada’s Policy Decisions
The Bank of Canada has shifted towards easing after a prolonged period of restrictive policy. In September 2025, it lowered the policy interest rate to 2.5%, following earlier cuts through the year. This move came after the economy contracted by 1.6% in Q2 2025, with exports dropping sharply, including a 24.7% decline in auto exports.
The decision reflects a balance between supporting growth and maintaining inflation near target. Policymakers have emphasized that trade disruptions and higher tariffs remain major risks to the outlook. According to the Bank’s Monetary Policy Report, uncertainty around U.S. trade policy continues to weigh heavily on forecasts.
The Bank has signalled it will remain flexible, adjusting rates if economic conditions worsen or if inflation pressures ease further. This cautious approach highlights the importance of stabilizing demand while avoiding a resurgence of price growth.
Inflation Trends
Inflation has stayed close to the 2% midpoint of the Bank’s target range, but underlying pressures have been more volatile. Earlier reports noted that while headline inflation was stable, core inflation had edged higher, reflecting persistent price growth in services.
Past interest rate hikes helped bring inflation down from its 2022 peak, but the path has not been smooth. The July 2025 Monetary Policy Report noted that inflation was holding near 2%, though the impact of tariffs could push prices upward in the months ahead.
Households have seen relief in essentials such as food and energy, but shelter costs remain elevated. The Bank continues to monitor whether wage growth and supply disruptions could keep inflation from returning sustainably to target.
Interest Rate Outlook
Markets expect the Bank of Canada to continue with a measured pace of cuts if growth weakens further. Analysts suggest that an additional 25 basis point reduction is possible if trade conditions deteriorate and domestic demand remains subdued.
The September 2025 press conference statement confirmed that the Governing Council is paying close attention to risks tied to global trade and financial stability. This indicates that future moves will depend on incoming data rather than a preset path.
For households and businesses, lower borrowing costs could provide some relief. However, the Bank has stressed that monetary policy alone cannot offset the drag from external shocks, particularly tariffs and weak global demand.
Implications for Employment and Recession Risk
The contraction of Canada’s economy by 1.6% in the second quarter has direct consequences for both the labour market and broader recession risks. Employment trends show early signs of strain, while forecasts point to weaker growth momentum if trade pressures and investment slowdowns persist.
Unemployment Rate Developments
Labour market conditions began to soften as the downturn took hold. Employment growth, which had been steady through late 2024 and early 2025, stalled in the spring. Statistics Canada reported no net job gains between February and April, with notable declines in manufacturing employment as tariffs disrupted cross-border supply chains.
The unemployment rate edged higher during this period, reflecting both reduced hiring and cautious business sentiment. Companies delayed investment and staffing decisions, particularly in sectors exposed to U.S. tariffs such as autos, steel, and energy.
A breakdown of recent employment changes highlights the uneven impact:
| Sector | Change (Spring 2025) |
|---|---|
| Manufacturing | -31,000 jobs |
| Wholesale/Retail | Flat |
| Services (Finance, IT) | Slight increase |
These shifts suggest that while job losses remain concentrated in goods-producing industries, service sectors are offering limited offset. Rising unemployment, even if modest, signals mounting pressure on households already coping with affordability challenges.
Recession Outlook for Canada
The 1.6% contraction in Q2 has raised concerns about whether Canada is entering a technical recession. Economists typically define this as two consecutive quarters of negative GDP growth. While Q1 showed modest expansion, the sharp Q2 decline has altered expectations.
Analysts note that trade tensions with the United States remain the central risk. The imposition of broad tariffs on Canadian exports has already slowed output and reduced investment confidence, as shown in the Spring 2025 economic report.
Key indicators to monitor include:
- Household spending: Growth has softened as consumers react to uncertainty.
- Business investment: Non-residential investment remains nearly 9% below pre-pandemic levels.
- Exports: Auto and resource shipments face sustained pressure from U.S. trade measures.
If these trends persist into the third quarter, the Canadian economy could meet the technical definition of recession by late 2025. The balance between resilient service activity and weakening goods production will determine the trajectory.
