Canadian Economy Contracts by 0.1% in May, Limited Growth Expected in Q2

Official data released on Thursday (July 31, 2025) showed that Canada's Gross Domestic Product (GDP) contracted by 0.1% month-on-month in May 2025, which was in line with expectations. However, preliminary estimates suggest a slight growth of 0.1% in June, which might lead the Canadian economy to record a weak annual growth of the same percentage during the second quarter of the year. These figures contradict prevailing estimates that had anticipated a contraction in the second quarter, and expectations may change once the final figures for June are released next month.

Retail Trade as a Major Drag

Retail trade was the primary driver of the economic decline in May, contracting by 1.2%. Seven out of 12 sub-sectors within the retail industry recorded a decrease in activity. Retail trade is a crucial part of the services industries, which account for approximately 75% of Canada's total GDP. This decline in a vital sector reflects the challenges facing consumers and businesses amidst current economic conditions.

Mixed Performance Across Economic Sectors

Despite the weakness in retail trade, the overall output of services industries remained unchanged in May. The decline in the retail sector was offset by better performance in the real estate and transportation sectors, indicating relative resilience in some parts of the service sector.

As for the goods-producing industries, which represent 25% of the total GDP, the mining, quarrying, and oil and gas extraction sector saw a notable decline of 1%. In contrast, the manufacturing sector grew by 0.7% after a sharp 1.8% contraction in April, which was a result of inventory accumulation. This mixed performance reflects the diverse nature of the Canadian economy and its susceptibility to various factors.

Impact of U.S. Tariffs on Exports and Growth

The Canadian economy had achieved robust year-on-year growth of 2.2% in the first quarter of the year, significantly boosted by increased exports to the United States before the implementation of tariffs in March. With these tariffs now in effect, exports and industrial production have notably declined, negatively impacting Canada's economic performance in the second quarter. This underscores the strong interconnectedness of the Canadian economy with the U.S. economy and its vulnerability to U.S. trade policies.

Bank of Canada Awaiting Further Data for Decision

The Bank of Canada kept its key interest rate unchanged at 2.75% on Wednesday (July 30, 2025). The bank had previously indicated its expectation of a 1.5% contraction in the second quarter, due to a 25% decline in exports. However, the new growth estimates, even if weak, might reduce the likelihood of a rate cut at the upcoming September meeting. The Bank of Canada will continue to closely monitor upcoming inflation and employment data, which will be crucial in determining its future monetary policy.

In the market, the Canadian dollar depreciated by 0.11% to trade at 1.3842 against the U.S. dollar (equivalent to 72.24 U.S. cents). Simultaneously, financial market bets on the Bank of Canada keeping interest rates unchanged at its next meeting on September 17 rose to approximately 89%, reflecting market expectations of a cautious central bank.