08:44 AM EDT, 09/02/2025 (MT Newswires) -- In Canada, the effects of United States President Donald Trump's trade war were clearly evident in Q2, with the economy contracting by 1.6% quarter-on-quarter annualized, said Commerzbank.

This was well below the expectations of analysts surveyed by Bloomberg, despite the Bank of Canada having recently predicted a similar slump, noted the bank.

However, as is often the case, a closer look is needed: private consumption grew considerably. Companies fared worse, with investments being significantly scaled back. In addition, exports practically collapsed -- annualized minus 27%. The latter is likely to be an exception, however, and should correct itself in the coming quarters.

Nevertheless, the figures have once again made it clear that the Canadian real economy is probably suffering the most from the U.S. trade war worldwide, stated the bank. Sentiment indicators are only slowly recovering from their historic slump in spring. For example, PMIs are still below the neutral level of 50, although the services PMI has recently recovered significantly (see lower left figure).

The Canadian labor market has been weakening for several months now, pointed out Commerzbank.

As to why the Canadian dollar (CAD or loonie) reacted with only slight weakness despite these figures, the bank added that growth figures usually provide a backward-looking view, and given the weak sentiment indicators in Q2 and the central bank's forecast, it's unlikely that the figures have changed the overall picture much.

The Bank of Canada is close to the end of its interest rate reduction cycle. Although a further interest rate cut is now more likely, it's unlikely that there will be any significant cuts into expansionary territory, according to the bank.

The upcoming data is likely to be much more significant for the CAD, said Commerzbank. For example, if the PMIs or the labor market report for August, due this week, indicate that weakness has continued into Q3, this would be a bad sign for the CAD.

However, continued solid private consumption and slowly recovering sentiment indicators, as well as the fact that Canada only received a slight further increase in U.S. tariffs at the beginning of August, give hope that the figures will at least stabilize. Another factor to consider for USD/CAD is that, in recent months, the Canadian real interest rate has decoupled from its U.S. counterpart.

The Federal Reserve's impending interest rate cuts, combined with rising U.S. inflation risks, are likely to reverse this trend, making the CAD more attractive against the US dollar, concluded the bank.