Market-implied odds of a quarter-point rate cut by the Bank of Canada next month shot up in the wake of this morning’s weaker-than-expected GDP reading for the second quarter.

Canada’s economy contracted in the second quarter by a much larger degree than anticipated on an annualized basis, as U.S. tariffs squeezed exports.

GDP for the quarter that ended June 30 contracted by 1.6% on an annualized basis from a downwardly revised growth of 2.0% posted in the first quarter, Statistics Canada said, taking the total annualized growth in the first six months of the year to 0.4%. This was the first quarterly contraction in seven quarters. StatsCan said the economy contracted by 0.1% in June.

Analysts polled by Reuters had forecast second quarter GDP to contract by 0.6% and the June monthly GDP to expand by 0.1%.

An advance estimate for July showed the economy could likely grow by 0.1% on a month-on-month basis, signaling that the third quarter might not be as bad as the previous one.

Money markets were predicting chances of a rate cut on Sept. 17 at close to 40% before the GDP figures were released. They shot up to about 47% after the data were released, implying almost equal odds of whether there will be a rate cut next month or not.

Monthly employment and CPI data will still be released before the Bank of Canada will make its decision on a September rate cut.

The Canadian dollar immediately reacted to the data, falling by two-tenths of a cent to 72.55 cents US. It didn’t take long for it, however, to recover.

U.S. inflation data released at the same time came in as expected, and had minimal impact on markets. Canadian bond yields also took an immediate turn lower, with both the 2-year and 5-year yields falling by about 3 basis points – even as their U.S. counterparts held nearly unchanged.

Here’s how implied probabilities of future interest rate moves stood in swaps markets moments after the 8:30 a.m. data, according to LSEG data. The current overnight rate is 2.75%. While the bank moves in quarter-point increments, credit market implied rates fluctuate more fluidly and are constantly changing. Columns to the right are percentage probabilities of future rate moves.

And here’s where the stood prior to this morning’s data:

Markets are now fully pricing in a quarter point rate cut by the end of this year, and looking further ahead, are putting roughly 50-50 odds on whether 2026 will see an additional quarter-point cut.

Here is how economists are reacting in written commentaries this morning:

David Rosenberg, founder of Rosenberg Research

“In sharp contrast to the U.S., where the AI spending boom is alive and well, Canadian business investment sagged by a sharp 33% annualized to its lowest level since the third quarter of 2020. This spells really bad news for the labour market because once companies start to trim capex, leaner hiring plans tend to follow. And this is at a time when the unemployment rate in Canada is far above its natural level, which is going to act as a dead-weight drag on wage growth. The chronic problem of ever-declining real GDP per capita is still with us, sad to say.”

“The monthly data for June (-0.1% MoM versus the consensus of +0.1%) and Statistics Canada’s estimate for July (just a +0.1% recovery) shows that there is no momentum in the Canadian economy as we move into the third quarter. The banking sector CEOs seem to like what they see in the local economy based on their post-results commentary this past week — but they must be looking at a different set of data. The third quarter is looking quite flat for real GDP growth (the BoC had been at +1.0% for the second half of 2025) after a -1.6% annualized shrinkage in the second quarter. Again, this may still not yet meet the C.D. Howe Institute’s definition of recession, but this sure looks to me like an economy that is residing right next door to that condition. What the Bank of Canada does or doesn’t do or say at the September meeting remains to be seen, but if I was at the helm, I would have no problem, not one iota, in restarting the rate-relief campaign.”

Veronica Clark, economist at Citi

“While weakness in H1 was largely due to trade-exposed parts of the economy, we continue to watch for weakness spreading more broadly. This would clearly concern BoC officials. But flat activity in the first half of the year already implies a modestly wider output gap with the economy in excess supply. We do not think policy rates at neutral will be sufficient to close this gap. We continue to expect a 25bp rate cut in September and policy rates reaching 1.75% next year.”

Andrew Grantham, senior economist, CIBC Capital Markets

“Monthly data for June was weaker than expected, showing a 0.1% reduction in GDP (consensus +0.1%) driven largely by a drop in the manufacturing sector. While that June drop is projected to have been reversed in July (+0.1% advance figure), that still leaves momentum heading into Q3 weaker than we or the Bank of Canada were likely expecting. Early tracking for Q3 is between 0-0.5% depending on growth rates assumed for the remainder of the quarter, in contrast to the Bank of Canada’s July MPR projection of +1%. That weaker than expected trend in the monthly figures makes today’s release supportive for our forecast of a September interest rate cut, although upcoming employment and CPI data will still be important for that call.”

Thomas Ryan, North America economist, Capital Economics

“The contraction in second-quarter GDP was largely due to a large drag from net trade, which is unlikely to be repeated, but the downward revision to GDP in Jun and preliminary July estimate showing only a muted gain leaves third-quarter GDP growth on track to be weaker than the Bank of Canada expected. That provides some supports our view that the Bank will soon resume cutting.”

“As the Bank of Canada had assumed a similar-sized second-quarter GDP decline, the second quarter expenditure figures have little direct implication for monetary policy. But the concern for the Bank is that its expectation for a 1% rebound in GDP this quarter now which looks overly optimistic in light of the 0.1% fall in GDP in June and preliminary estimate of only a muted 0.1% gain. The upshot is GDP is tracking a disappointing 0.5% this quarter, undershooting the Bank’s forecast and making a September cut look a bit more likely.”

Royce Mendes, managing director and head of macro strategy, Desjardins Securities

“Simply put, the tariff war with the US was terrible for the Canadian economy. … The good news is that trade tensions between Canada and the US have been easing. With most goods passing the border USMCA compliant, the exemptions from both Canada and the US are meaningful. First and foremost, tail risks to the Canadian economy have diminished significantly. Moreover, the reduction in retaliatory tariffs will remove any lingering concerns at the Bank of Canada about tariff-induced inflation. That said, the Canadian economy is still far from firing on all cylinders.”

“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. Government of Canada bond yields are falling, as analysts in the “no cut” camp revisit their assumptions and traders begin to price in more easing. That said, we remain of the view that the central bank will do more than what the market is pricing even after today’s moves.”

Derek Holt, vice-president, Scotiabank Economics

“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 and particularly from the standpoint of what policy should do about it.”

“Yes, GDP disappointed expectations, for starters. Q2 GDP shrank by –1.6% q/q SAAR and so hats off to the BoC’s estimate in the July MPR that was closest, although that was a mountain of data ago and so luck also likely played a bit of a role alongside noisy trade and inventory swings that are hard to estimate. … And yes, the monthly GDP figures aren’t great. They’re not terrible either, but –0.1% m/m SA in June and +0.1% m/m in July’s early estimate signals soft momentum.”

“But the key here lies beneath the hood. The domestic economy ripped higher in Q2. The measure of relevance in that regard is final domestic demand which adds consumption plus investment plus government spending and hence does not include trade and inventory effects. FDD was up by a whopping 3.4% q/q SAAR in Q2.”

“The BoC should emphasize the final domestic demand detail— which they have always tended to do in their statements at times like this—and fade the headline GDP number. I still want to see next Friday’s spin of the wheel for Canadian jobs (+35k is my estimate) and then the next week’s CPI figures and other information, but the market may not be correctly interpreting what these numbers mean to the BOC.”

“In general, the rate sensitive areas of the economy are accelerating. We see that in home sales that are up 3 months in a row, housing starts that are up 4 months in a row, retail sales that are doing fine, and auto sales that are up. And now look at the consumption and housing components of GDP that were very strong.”

“Obviously there are risks ahead, but they are two tailed, not all on one side. Trade uncertainty is a modest risk at this point with a minimal effective tariff shock and flexible currency with bidirectional uncertainties into the CUSMA negotiations; the biggest risk to Canadian exports is whether US growth proves to be resilient or not which puts the income pull effect on Canadian exports ahead of tariff-related price sensitivities. On the other hand, 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. There are 12–24 month lags for monetary policy actions and so a lot of the rate pass through to what’s been done is still ahead.”

Benjamin Reitzes, managing director, Canadian rates and macro strategist, BMO Capital Markets

“For the BoC, there’s nothing here screaming for a September cut, though it will certainly keep the chatter around further easing intact. The Bank had Q2 GDP at -1.5%, so the miss was minor. And, the strength in domestic demand highlights the economy’s resilience. One negative is that Q3 is tracking softer than their +1% estimate (closer to +0.5%), but it’s still very early, and things can change materially.

Key Takeaway: It should come as no surprise that the Canadian economy struggled in Q2 as tariffs ramped up. However, the domestic strength is somewhat comforting, although the sustainability of that momentum is an open question. Arguably, the economy is evolving largely in line with the BoC’s July MPR forecast. Policymakers opted to stay on hold then, so this report likely doesn’t push them any closer to cutting in September, with the LFS [Labour Force Survey] and CPI still to come.”

Rishi Sondhi, economist, TD Economics

“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.”

Matthieu Arseneau and Kyle Dahms, economists at National Bank

“We now have the full picture for the first quarter in which U.S. tariffs were imposed, and it is far from reassuring. The Canadian economy posted its sharpest contraction since the pandemic, as the drop in exports far exceeded the decline in imports. As a result, trade made its largest negative contribution ever, with the exception of the temporary distortion caused by the pandemic.”

“Overall, this morning’s data does not change our view that the Canadian economy, already in excess supply, has experienced difficulties in the second quarter and will in the third. The revision of monthly GDP for June (preliminary was 0.1% and was revised to -0.1%) and the weak rebound in July lead us to believe that the economic weakness will continue into the third quarter. Moreover, yesterday’s labor market data points to a widespread deterioration in the labor market (link), which should limit consumption in Q3, especially as households grapple with an interest payment shock at current rate levels . This economy seems in dire need of a trade agreement to give businesses greater visibility. In the meantime, the Bank of Canada can provide a little extra help while waiting for the federal government’s budget plans.”

Michael Davenport, senior economist at Oxford Economics

“Rising USMCA compliance and lower Canadian counter tariffs are helping to cushion the impact of the trade war on Canada’s economy, and it looks increasingly likely that GDP may avoid another contraction in Q3. However, the impact of the trade war and elevated uncertainty on sentiment, capital spending, and hiring will likely continue to build. We expect the economy will struggle to grow in H2 and teeter on the verge of recession.”

David Doyle, head of economics at Macquarie Group

“There are causes for more optimism in 2026. The potential for an improvement in US activity should have positive implications for Canada’s business cycle, notwithstanding trade policy uncertainty. For the BoC ahead, we continue to project two further rate cuts of 25 bps each, with the most likely timing for these being in October and December.”

With a file from Reuters