07:17 AM EDT, 09/02/2025 (MT Newswires) -- As summer winds down, last week's economic calendar heated up in Canada, said TD.

The headline release was Q2 gross domestic product, offering the first hard look at how Canada's economy coped under the weight of tariffs, noted the bank. The economy contracted 1.6% quarter-over-quarter annualized -- in line with both TD's own tracking and the Bank of Canada's July scenario, but weaker than consensus expectations for a modest 0.7% decline.

Markets took the news in stride: equities gained nearly 1%, 10-year yields slipped, and the Canadian dollar (CAD or loonie) inched up toward US$0.73, even as the US dollar (USD) strengthened elsewhere.

The numbers laid bare the economics of a trade war, stated the bank. Exports plunged by a whopping 27% in Q2, with autos, machinery, and travel services hit especially hard. Imports also fell, but by less than exports, leaving net trade to carve a hefty eight percentage points off growth.

Last Thursday's international balance of payments release foreshadowed this outcome, reporting a record-low current account deficit of $21.2 billion.

Business investment provided no relief, added TD. Machinery and equipment spending dropped sharply, driving the 10% quarterly decline, though structures spending rebounded thanks to a one-off import tied to an offshore oil project in Newfoundland and Labrador. A brighter spot came from residential investment, which regained some ground after its steep Q1 fall, helped by the recent surge in new home construction.

There were more positive signals elsewhere, according to the bank. Inventory accumulation and government spending both contributed positively to domestic demand, which excludes net exports and rose solidly in Q2 2025, following a decline in Q1.

The real surprise came from households. Personal consumption jumped: durable goods rebounded from their Q1 slump, semi-durables and non-durables posted more modest gains, and services spending recorded its strongest gain since early 2024. Some of this reflected tariff-related front-running, but it also showed consumers' willingness to spend despite a softening job market. Whether this resilience can hold is doubtful: early retail data for July point to cooling momentum, and slower wage growth will weigh on spending in the second half of 2025.

Taken together, the data shows an economy caught between trade-driven weakness and surprisingly sturdy domestic demand, said the bank. The former makes the case for further monetary easing, while the latter could temper how quickly the BoC moves.

With Canada's retaliatory tariffs now lifted and trade talks resuming, uncertainty may begin to ease for businesses. Still, as Governor Tiff Macklem reminded in his remarks last week, monetary policy cannot "offset the hit to efficiency from higher tariffs and the reconfiguration of trade."

What it can do is cushion the blow. With the current policy rate still sitting at the midpoint of the BoC's estimated neutral range, the Q2 contraction only strengthens the case for more cuts this year. Markets are now pricing a 55% chance of a cut in September, noted TD.