Market odds shift as labour weakness and trade hit fuel debate on rate cut
Canada’s economy contracted 1.6 percent in the second quarter, the steepest drop since the pandemic, according to Statistics Canada, fuelling debate over whether the Bank of Canada will cut rates at its September 17 meeting.
The contraction, which reversed a 2 percent annualized expansion in the first quarter, was far worse than the -0.7 percent average estimate, reported by the Financial Post.
Exports to the US fell 7.5 percent between April and June.
Statistics Canada also reported the current account deficit widened to $21.16bn in the quarter, the largest since the early 1980s, compared with $1.32bn in the first three months of the year when exporters benefited from tariff front-running.
Markets are now pricing in a 55 percent chance of a September cut, as per TD Economics economist Rishi Sondhi, who said weaker US demand and tariff effects “walloped” Canada’s second-quarter GDP.
According to the Financial Post, Sondhi said that consumer resilience surprised policymakers, though “ongoing slack” could continue to push down inflation.
Desjardins Securities managing director Royce Mendes said in a note that the “tariff war with the US was terrible for the Canadian economy.”
While he sees trade tensions easing, Mendes expects flat or slightly negative third-quarter growth and is sticking with a call for a September cut.
Meanwhile, Statistics Canada’s survey of employment, payrolls and hours (SEPH) showed a June loss of 32,500 jobs, further raising expectations of policy easing.
CIBC Capital Markets associate Noah Buffam said in an email the odds of a cut at the September meeting now stand at 50-50.
Buffam highlighted that SEPH is less volatile than the Labour Force Survey, which recorded an 83,000 gain in June followed by a 41,000 drop in July.
He said the SEPH report revealed weakness spreading to non-tariff-affected sectors, including retail, construction, health care and social assistance.
Retail employment fell by more than 8,000 positions in June, construction declined by nearly 5,200, and manufacturing dropped by about 8,300, Statistics Canada reported.
Manufacturing jobs have fallen by 26,600 since January, with transportation equipment the largest contributor, followed by chemical and machinery manufacturing.
BMO Capital Markets economist Shelly Kaushik said in an email that “the big picture is one of building slack in the labour market,” citing the rising jobless rate and the number of unemployed people per job vacancy.
Statistics Canada reported there were 3.2 unemployed people per job vacancy in June, up year over year, while the unemployment rate climbed to 6.9 percent from 6.6 percent in January.
Bank of Canada governor Tiff Macklem said at the last policy announcement, when rates were held at 2.75 percent for the third consecutive time, that governors were watching how much “spillover” there is from tariff-affected sectors.
“If those spillovers are bigger and there is more downward pressure on inflation and the upward pressure from tariffs and trade disruption is contained, there may be a need to cut interest rates further,” Macklem said.
BMO’s managing director Benjamin Reitzes noted in a client note that second-quarter GDP “wasn’t all bad news,” pointing to a 4.5 percent rebound in household spending and a 6.3 percent gain in residential investment.
“For the Bank of Canada, there’s nothing here screaming for a September cut,” he said, though he added that signs of weaker third-quarter growth could pose a risk.
