Current conditions

Canadian economic activity has slowed considerably because of the trade conflict but is showing signs of resilience. While inflation is close to 2%, underlying inflation has risen to about 2½%.

The trade conflict disrupted the Canadian economy in the first half of 2025. In the first quarter, trade was pulled forward in anticipation of tariffs, and exports grew rapidly. As a result, Canada’s gross domestic product (GDP) rose by 2.2%. At the same time, growth in final domestic demand stalled as uncertainty about the trade environment began to weigh on business and household spending.

The impact of tariffs on economic activity continued to play out in the second quarter; GDP is estimated to have fallen by 1.5%.

• Exports fell because trade activity brought forward in the two previous quarters was reversed and tariffs were imposed.
• Heightened uncertainty weighed on spending by businesses and households.
• Job losses were concentrated in sectors that rely on trade. Employment in the rest of the economy continued to grow modestly.

Consumer price index (CPI) inflation was 1.9% in June. CPI inflation excluding indirect taxes rose from about 2% in the second half of 2024 to 2.5% in June. This is largely due to higher inflation in prices for non-energy goods. Price increases in shelter services are holding inflation up but have continued to ease as expected.

Tariffs have had only a limited effect on inflation to date. Household inflation expectations remain elevated, while businesses’ inflation expectations have moderated. Some businesses, however, report that the shifts in global trade are imposing new costs on their operations.

Economic activity

GDP growth for the first quarter of 2025 was stronger than expected at 2.2%. Trade activity was brought forward ahead of anticipated tariffs, boosting growth. Exports surged, and the drag from higher imports was offset by a strong pick-up in inventories.

In contrast, final domestic demand was flat in the first quarter. Residential investment fell, led by a steep decline in housing resale activity. Government spending was pulled down by shipments of military aid to Ukraine.1 Growth in consumption and business investment slowed because of heightened uncertainty about US trade policy, along with a pullback after strong growth in the fourth quarter of 2024.

In the second quarter of 2025, GDP is estimated to have contracted by 1.5%, primarily due to a sharp drop in exports after tariffs were imposed (Chart 1). The effects of tariffs and trade uncertainty also continued to weigh on household spending and business investment. A rebound in government spending after weakness in the first quarter provided a partial offset.

Trade has fallen sharply

Exports look to have fallen by around 25% in the second quarter. This decline is due to a sharp fall in exports to the United States (Chart 2), reflecting a number of factors:

• a broad-based reversal of the pull-forward of trade activity in the two previous quarters
• the imposition of tariffs
• temporary disruptions to oil shipments
• fewer visitors to Canada

These factors were partially offset by resilient foreign demand and increased trade with countries other than the United States.

Imports are estimated to have fallen by about 10% in the second quarter. The decline in goods imports reflects both a broad reversal from the first quarter and the impact of Canadian countermeasures to US tariffs. A drop in the number of Canadians travelling to the United States also weighed on services imports.

Inventories are estimated to have expanded further, adding to GDP growth.

Growth in final domestic demand is muted

Final domestic demand was flat in the first quarter of 2025. Consumer spending and business investment continued to grow but at a slower pace than in the fourth quarter of 2024. This modest growth was offset by an 11% fall in residential investment and a decline in government expenditures.

In the second quarter of 2025, growth in final domestic demand is estimated to be just above 1%, supported by resilience in growth in consumption, along with increased government spending. Declines in business and residential investment partially offset this increase.

Consumption growth is estimated to be about 1%, reflecting a soft labour market and slowing population growth. While results from the Canadian Survey of Consumer Expectations (CSCE) for the second quarter of 2025 suggest consumer sentiment declined, some other surveys indicate an improvement more recently.

Government spending is estimated to have picked up by about 3.5% after the temporary decline in the first quarter.

Residential investment is estimated to have contracted again in the second quarter—albeit at a slower pace—falling about 2% amid elevated uncertainty.

• Resale activity continued to decline on average in the second quarter. The level of resale activity remains weak in Ontario and British Columbia but is more robust across the rest of the country.
• Growth in new construction moderated after strong increases over the past year.
• Renovation activity fell due to rising costs and declining housing prices.

However, resale activity and housing starts in May and June point to a pick-up in the near term.

Business investment is estimated to have fallen by 1%, reflecting subdued sentiment and continued trade uncertainty.

Capacity pressures

Trade tensions have weakened economic activity and have led to excess supply in the economy. Many businesses expect demand to soften and have paused their hiring and investment plans.2 Job growth bounced back in June after four months of little gain. Nevertheless, the unemployment rate remains elevated. Overall, the labour market continues to be in excess supply.

With GDP likely to have contracted in the second quarter of 2025, the output gap is estimated to have widened to between -1.5% and -0.5% from between -1.0% and 0% in the first quarter.

The labour market is soft

Although job growth picked up in June, the labour market remains soft (Chart 3). The unemployment rate rose from 6.6% at the beginning of the year to 6.9% in June. Weakness in industries that are sensitive to trade is the main reason for the softening in the labour market (Chart 4). Employment continued to grow in industries that are less sensitive to trade.

Job vacancies continued to decline, and the Bank’s business surveys indicate that hiring intentions remain subdued.

Most indicators of labour costs—including measures of wage growth and unit labour cost growth in the business sector—continued to ease (Chart 5).

While tariffs and counter-tariffs have had only a limited direct effect on inflation to date, Canadian businesses indicate that adapting to the changing global trade environment is adding to their costs.

Measures of core inflation have risen from 2024 and range between 2.5% and 3.0%. The distribution of inflation rates across CPI components has shifted somewhat higher, with more rising above 3% and fewer below 1%. Overall, underlying inflation is estimated to be about 2½%.

Non-energy goods inflation has continued to rise

Energy prices declined considerably when the consumer carbon tax was removed (see In focus: How removing the consumer carbon tax affects inflation in the April Report). Inflation in energy prices fell to -9.5% in June.

Inflation in prices for goods excluding energy has increased to 2.2% from about zero in the second half of 2024, above its historical average (Chart 8). This rise is primarily attributed to the pass-through of past increases in import costs across a broad range of products, from motor vehicles and furniture to clothing and coffee. These increases in import costs reflect:

• the depreciation of the Canadian dollar against the US dollar in late 2024, which made imports more expensive
• past elevated growth in container shipping costs
• past increases in agricultural prices

However, with the recent appreciation of the Canadian dollar and slower growth in shipping costs, the impacts of the cost pressures not related to tariffs are expected to ease in the coming months. In contrast, Canadian businesses have indicated that adapting to the evolving global trade environment is already adding to their costs. These cost pressures may persist.

Services price inflation has eased modestly

Inflation in services prices was 3% in June, 0.5 percentage points lower than in the second half of 2024.  

While shelter price inflation remains above its historical average (Chart 9), it has continued to gradually decline:

• Rent inflation has eased since the start of 2025 and was 4.7% in June, likely reflecting increasing rental supply and slowing population growth.
• Growth in mortgage interest cost slowed to 5.6%.

Inflation in services prices excluding shelter picked up from about 2% in the second half of 2024 to 2.7% in June, close to its historical average. The increase since late last year is primarily due to less deflation in some prices, such as for communications and travel tours. Services associated with travel-related spending in Canada, such as hotels and rental cars, also faced some upward price pressures. At the same time, the growth of wages, a key cost for services, eased.

Measures of core inflation have risen since late last year and currently range from about 2.5% to 3% (Chart 10). CPI-median and CPI-trim are at the high end of that range. Other measures of underlying inflation have also risen, although they are slightly lower. For instance, CPIX and CPIXFET have been around 2.5% in recent months. All these measures are still somewhat affected by persistently high shelter price inflation.

The share of CPI components rising by more than 3% year-over-year has moved up and is above its historical average (Chart 11). The share running below 1% has fallen and is now close to its historical average. This pattern of price growth is typically associated with inflation of around 2½%.

Based on all these measures, the Bank of Canada assesses underlying inflation to be about 2½%.

Businesses’ short-term inflation expectations have moderated

Businesses’ short-term inflation expectations have fallen, returning close to levels last seen at the end of 2024. In contrast, households’ short-term inflation expectations have remained unchanged after the increase in the first quarter (Chart 12).