The Canadian economy contracted by 1.6% quarter/quarter annualized (q/q, AR), a steeper decline than expected by consensus, but nearly bang-on our updated tracking. The first quarter was revised slightly lower (+2.0% q/q from +2.2 q/q). Looking ahead to the third quarter, the flash estimate for July showed a 0.1% monthly increase, after a 0.1% month/month contraction in June.
Consumer spending made massive contribution to overall GDP growth, clocking in at a hefty 4.5% annualized pace. Solid spending gains were observed for durables, semi-durables, and services. Inventory accumulation was the other big growth driver.
Residential investment advanced 6% q/q in Q2 – a partial rebound from the hefty 12% q/q drop in the first quarter – driven by new construction. In contrast, non-residential investment plunged 10% q/q, weighed on by a 33% q/q decline in machinery and equipment. Meanwhile, structures investment rose 6%, although this was largely driven by the one-off import of a module for an offshore oil project in Newfoundland and Labrador.
Exports contracted by 27% q/q, while imports fell 5% q/q. The difference carved 8 percentage points from overall GDP growth. Exports were notably weak for autos, industrial machinery, equipment, and parts, as well as travel services. For imports, hefty pullbacks were recorded for passenger vehicles and travel services.
Key Implications
As expected, the economy contracted in the second quarter, as exports were walloped by the one-two punch of weaker U.S. demand and the unwind of a tariff-front running induced surge in Q1. Final domestic demand held up much better than overall GDP (+3.5% q/q), buoyed by a surprisingly strong, broad-based surge in consumer spending and one-time equipment import for an offshore oil field in Newfoundland and Labrador. Moving forward, consumption growth could ease from its hefty second quarter pace, reflecting the cooler jobs market. Note that employee compensation advanced at its slowest pace since the pandemic in the second quarter.
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. On the margin, this could enhance the argument for the Bank to stand pat on rates at their September 17th meeting. However, policymakers still have one more jobs and inflation report to digest before that time. The contraction in overall GDP also implies that slack built in the economy in Q2, and even with a better performance in Q3 likely on tap, the economy probably remains in excess supply. This points to further downward pressure on inflation and could pave the way for more rate cuts this year (see our updated forecast), especially with a policy rate only at the mid-point of what the Bank considers neutral for the economy. For their part, markets are pricing in a 55% chance of a cut in September, although one taking place by year’s end is fully priced in.
