Canada's economy may not be as weak as the headlines suggest
Canada’s economy contracted in the second quarter, but economists caution that the headline figures mask underlying strength. Some believe cutting interest rates further could be a policy mistake.
Gross domestic product shrank 1.6% on an annualized basis in the second quarter, with June marking the third consecutive monthly decline at –0.1%. Statistics Canada’s preliminary estimate points to a modest 0.1% rebound in July.
“Canada’s economy was much stronger than the headline GDP reading would suggest—so much so that it’s a textbook example for students of how sometimes GDP isn’t a great measure,” said Derek Holt, vice-president and head of capital markets economics at Scotiabank Economics. “The domestic economy ripped higher in Q2.”
Much of the weakness came from trade. Exports plunged 27% in the quarter, subtracting nearly 10 percentage points from GDP, after businesses front-loaded shipments earlier in the year to avoid US tariffs. Imports also fell, cushioning some of the drag.
Consumers and housing drive growth
Final domestic demand—consumption, investment, and government spending, excluding trade and inventory effects—rose 3.4% in the quarter.
Consumer spending surged 4.5% at an annualized rate, contributing 2.4 percentage points to GDP growth, while housing investment jumped 6.3%. Holt pointed to home sales rising for three straight months and housing starts climbing for four as evidence that previous Bank of Canada rate cuts are beginning to take effect.
“In general, the rate-sensitive areas of the economy are accelerating,” he said.
Market bets versus central bank caution
Bond markets raised the probability of a rate cut at the Bank of Canada’s September 17 meeting to 48% following the GDP release. The central bank has held its policy rate at 2.75% since March after seven consecutive cuts.
Some analysts argue a cut is warranted. “As a result of the headline miss for Q2 and no signs of momentum heading into the third quarter, we are retaining our forecast that the Bank of Canada will resume its cutting cycle in September,” said Royce Mendes, managing director and head of macro strategy at Desjardins.
Others, however, believe policy should stay on hold. “Policymakers opted to stay on hold [in July], so this report likely doesn’t push them any closer to cutting in September, with the LFS and CPI still to come,” said Benjamin Reitzes, managing director at BMO Economics.
Rate cuts still working through
Holt stressed that earlier easing has not fully filtered through the economy. “We’ve only just begun to see pass through of rate cuts. The first in July of last summer is only at the one-year anniversary and the last in March is still just a baby,” he said. Monetary policy typically takes 12 to 24 months to fully transmit through the economy.
With jobs data due Sept. 5 and inflation figures on Sept. 16, the central bank has time to weigh whether more stimulus is needed. For now, many economists caution against acting too soon.
“The Bank of Canada should emphasize the final domestic demand detail—and fade the headline GDP number,” Holt said.
