MNI: Canada Q2 GDP -1.6% As Tariffs Hit Exports, July +0.1%

Canada's GDP declined at a 1.6% annualized second-quarter pace as U.S. tariffs beat down automobile exports, though domestic demand climbed 3.5% and a flash measure showed monthly output picked up again to start the third quarter.

Statistics Canada's flash GDP measure for July climbed 0.1%, halting the first three-month string of declines since the end of 2022. Real estate, wholesaling and mining led gains while retail sales declined. 

The potential return to growth in the third quarter could be crucial as Bank of Canada officials debate whether to cut interest rates at their Sept. 17 announcement. Governor Tiff Macklem held rates for a third time in July after seven previous cuts and said he could trim if the economy stumbles and inflation is under control, providing scenarios around the damage from the U.S. trade war instead of a regular forecast. The Bank's status quo scenario had GDP contracting at a 1.5% second-quarter pace and returning to growth at a 1% pace in the third quarter, suggesting Friday's report may not shake up the Bank's thinking. 

The output decline from April to June was the first since 2023 and the largest since the pandemic. Almost all the weakness came from exports, down at a 27% annualized pace that was the biggest outside of the pandemic since 2009 during the global financial crisis. Automobile exports suffered as the U.S. imposed tariffs and so did machinery and equipment shipments. Those exports had surged earlier as American dealers stockpiled in anticipation of trade penalties. 

The GDP decline was blunted as household spending gained 4.5% and business inventory accumulation provided a boost. Business investment dropped 10%, though that has a small weight in the overall pace of GDP. 

There has been some easing of trade tensions with the U.S. in recent weeks as Prime Minister Mark Carney announced he would drop most retaliatory tariffs on Sept. 1 in a bid to quicken a deal with Donald Trump. The BOC's de-escalation scenario had GDP rebounding to 2% growth in the second half of the year, assuming the U.S. cut tariffs on Canada in half and pulled back on global measures. 

Economists are divided on whether the Bank will hold or cut at the September meeting. Before the decision there is a jobs report Sept. 5 and inflation the day before the rate announcement, though by that point officials will likely have written a draft communique. Officials have said they will be less forward looking at a time of trade uncertainty and must make sure tariffs don’t turn into a wider inflation problem. 

Other evidence about slack in the economy has been mixed. Headline inflation has stabilized around 2% but core measures are closer to 3%, and other trend measures the BOC tracks are about 2.5%. The jobless rate has also crept up over the last year before the government started curbing immigration. The last job report showed a surprise 40,800 fall in employment, the biggest in more than three years.

There are also slower-moving risks as the government prepares a fall budget costing out increased deficit spending on NATO's defense target. Consumers are refinancing popular five-year fixed-rate mortgages taken out when borrowing costs were at record lows, and the government's move to slash immigration could slow demand and ease pressure on housing costs.