Economy rebounds in the second quarter, but trade tensions could shift outlook

Canada’s economy was firmly on the mend in the second quarter after a rocky start to the year, but the recent turn in Canada’s trade war with the United States risks disrupting the momentum for the balance of the year.

Real gross domestic product expanded at an annualized rate of 3.3 per cent in the second quarter, roughly matching economists’ expectations, Statistics Canada said on Friday. It was Canada’s strongest quarter for growth since the third quarter of 2024.

At the same time, Statscan revised first-quarter growth into positive territory, at 0.3 per cent, from a previous small decline, meaning Canada didn’t experience two consecutive quarters of negative growth – a situation sometimes referred to as a “technical recession.”

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However, an advanced estimate for July showed zero growth from the month before, suggesting the solid start to the summer may have been short lived.

While strength in the second quarter was broad-based, exports were the largest contributor to growth and increased at their fastest pace in more than three years, with vehicle shipments leading the way.

But an economic rebound led by strong exports suddenly seems precarious given the barrage of new tariffs and threats of steeper ones from the U.S. President Donald Trump’s administration.

“I’d be very careful to label this a victory for Canada’s economy,” said Torsten Jaccard, a professor at the Vancouver School of Economics at UBC. Friday’s report might be the kind of short-run noise that occurs in a “highly volatile policy environment,” he added.

While business investment increased in the quarter – driven by higher spending on machinery and equipment – it’s set to be challenged as trade relations deteriorated between Ottawa and Washington, resulting in U.S. tariffs of 50 per cent on goods previously shielded by the U.S.-Mexico-Canada trade pact.

The levies, set to target $28-billion or 5 per cent of shipments to the U.S., came into effect Aug. 22, just hours after trade talks between the countries collapsed.

Economists expect the impact to be concentrated in targeted sectors, but retaliatory tariffs announced by Ottawa set to take effect Sept. 8 are expected to add modest inflation pressure and potentially provoke further harmful U.S. trade policies.

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Tariffs on both sides of the border will hit industries with heavily integrated supply chains the hardest, such as manufacturing, said LJ Valencia, an economist at Desjardins.

“There won’t be as much of an incentive to produce or to expand production if fees are being slapped on either the U.S. or Canada,” Mr. Valencia said.

If tariffs remain in place, not only does the short-term outlook change, but it could reshape the path for medium- to long-term growth.

“We’re talking about decades and decades of our economic relationship with our southern neighbour, the United States, being upended because of this escalation of trade tensions,” he said. “If you think about how that is going to change the economy moving forward, it’s going to be a big and drastic adjustment period.”

Growth in the second quarter was also driven by higher household spending on investment services, cars and rent.

Real GDP per capita, which had been stalled for several years amid a weak economy and record-high population growth, also ticked up as Canada’s population shrank for the third quarter in a row.

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However, after experiencing unsustainable levels of immigration in recent years, it’s normal and healthy that there would be a short-term adjustment period with population decline, Prof. Jaccard said.

“It’s quite clear that this has brought the growth in rent prices and house prices under check a little bit. A huge part of well-being in this country is getting house prices in our major urban areas back in line with income levels.” That, he said, could help growth in the long run.

If the tariffs remain in place over the next couple of years, Canada will be forced to re-evaluate what it produces and exports in a world where the U.S. market is not as open to us as it once was, Prof. Jaccard said.

That means having difficult conversations around the targeted industries.

“We should be supporting those industries in the short run because it’s possible that these tariffs are a flash in the pan,” he said. But in the long run, Canada should instead take the approach of protecting of workers but not necessarily jobs, he added. “And that’s a very difficult thing to do.”

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For the balance of the year, trade uncertainty and tariffs will be a headwind for GDP growth. It could also lead to higher a unemployment rate, which Desjardins economists said could reach 7 per cent by the end of the year if the newly introduced tariffs remain in place.

Additionally, without a resolution in the Iran war, oil prices will remain significantly elevated and could feed into inflation.

On the other hand, elevated oil prices will continue to give a lift to Canada’s tariff-ridden economy as a net oil exporter.

As for what the latest growth numbers mean for interest rates, economists on Bay Street expect the Bank of Canada to hold its benchmark rate at 2.25 per cent at the Sept. 2 meeting.

“Given this context, we still maintain our view that the Bank of Canada is likely to remain on the sidelines until 2027,” Mr. Valencia said.