Economy stalled in August, raising questions about Bank of Canada's next rate hike

New data shows the Canadian economy did not grow in August, missing expectations and fuelling debate over the Bank of Canada's next move on interest rates. Statistics Canada reported Friday that real gross domestic product was essentially unchanged for a second straight month, falling short of its own early forecast for a 0.2 per cent gain. The agency's preliminary estimate for September suggests a 0.1 per cent decline, driven by losses in manufacturing and resource extraction. This follows a Bank of Canada decision on Wednesday to raise its key interest rate for the first time in over three years.

The August stall was driven by a 1.4 per cent drop in wholesale trade and a 5.8 per cent decline in motor vehicle and parts manufacturing, which Statistics Canada attributed to a prolonged summer shutdown at a major auto assembly plant. Tu Nguyen, chief economist at RSM Canada, said these sectors only partially reflect the impact of a breakdown in Canada-U.S. trade talks that month. "Manufacturing and wholesale trade, sectors that are particularly vulnerable to tariff disruptions, will continue to see regular contractions under the re-escalated trade dispute," Nguyen said. Both nations have since imposed new tariffs and trade restrictions. Other factors dragging on growth included the winding down of work to prepare the 2026 census and maintenance at some nuclear power plants and mining facilities in northern Alberta. Gains in retail trade, overall manufacturing, and transportation and warehousing helped offset some of the declines. The agency's flash estimate suggests the economy grew at an annualized rate of 1.3 per cent in the third quarter, a slowdown from 3.3 per cent in the previous quarter and below the central bank's updated forecast of two per cent.

Many economists argued the weaker-than-expected data puts the Bank of Canada's more optimistic projections at risk. BMO chief economist Doug Porter noted some weakness might be overstated due to census-related slowdowns, but he identified broader challenges. "Still, with the trade tiff still flaring, housing struggling, and recent employment figures concerning, it certainly appears that growth has run into some pretty serious headwinds of late," he said. BMO subsequently lowered its third-quarter growth forecast to 1.5 per cent from two per cent. Andrew Grantham, a senior economist at CIBC, said the figures indicate the economy was losing steam before this week's rate hike. "The August data suggested the economy 'was already struggling for momentum even before this week’s interest rate hike,'" he wrote, adding that slower growth could ease inflation and reduce the need for further hikes. Grantham said the weak results support a pause at the Bank of Canada's December meeting, though more data will arrive before then.

Financial markets on Friday morning priced the odds of a December rate hike at 57 per cent. Nguyen called the timing of the next increase a "coin flip" between December and January, but she leans toward a sooner move given the central bank's focus on inflation. "A 25-basis-point hike, one month apart, whether in December or in January, I don’t think would change too much in terms of growth trajectory," she said. The Bank of Canada anticipates a fourth-quarter slowdown before growth returns to two per cent in 2027 and 2028. Despite the recent slowdown, Nguyen pointed to reasons for optimism next year, including government spending on major projects and business investment tax incentives. Statistics Canada will release its official third-quarter GDP figures, along with the September data, next month. Yadude Books reported this week that the central bank's rate hike is expected to add pressure to a housing market already projected to shrink this year.

With files from The Canadian Press, BNN Bloomberg and The Globe and Mail