Canadian GDP Growth Accelerates to 2.2% in Q1, but Underlying Weakness Signals Caution for Rate Decisions

Canada’s economy defied softer expectations in the first quarter, with GDP expanding at a 2.2% annualized pace—surpassing the 1.7% consensus forecast. However, beneath this headline strength lies a mixed picture that’s complicating the Bank of Canada’s monetary policy outlook, particularly as domestic demand shows signs of cooling.

The Export-Led Rally Masks Deeper Concerns

Statistics Canada released the figures Friday, revealing that first-quarter expansion marked the fifth consecutive quarter of growth exceeding 2%, a modest improvement over the prior quarter’s revised 2.1% gain. The outperformance stemmed primarily from a surge in exports, with automotive shipments and industrial equipment leading the way as businesses rushed to beat anticipated U.S. tariff implementations.

Inventory accumulation also bolstered the headline figure, partially offsetting headwinds from weaker business investment and consumer spending. Yet this composition raises questions about sustainability. Final domestic demand—the broadest measure of internal spending—contracted by 0.1% on an annualized basis after climbing 5.2% in the previous quarter, signaling that the Canadian economy’s near-term strength may rest on temporary trade-driven factors rather than fundamental vitality.

Domestic Demand Shows Clear Deterioration

The softening in household consumption provides the sharpest warning sign. Annualized spending growth decelerated sharply to just 1.2% from 4.9% in the prior quarter, with residential investment particularly hard-hit. Home resale activity posted its steepest decline since early 2022, while government spending also retreated.

This pullback reflects broader economic fragility. Bank executives have flagged declining consumer sentiment and real estate weakness as primary concerns, with several major lenders recently increasing loan-loss provisions. Royal Bank of Canada CEO David McKay acknowledged Thursday that while he doesn’t foresee recession in either Canada or the U.S., “the prevailing uncertainty does mean consumers are spending less, particularly on discretionary items, and businesses are freezing big spending plans.”

The Central Bank’s Dilemma

The Bank of Canada now faces a delicate balancing act. The central bank had projected 1.8% growth for Q1 and paused its rate-cutting cycle in April after seven consecutive reductions since June. With the GDP print coming in above expectations but underlying demand deteriorating, the path forward remains murky.

According to Dominique Lapointe, senior director of macroeconomic strategy at Manulife Investment Management, “If the governing council was looking for more clarity at its April decision before deciding on their next move, there is none.” Market pricing now assigns minimal odds to a rate cut at the Bank of Canada’s June 4 meeting, with Lapointe forecasting a “dovish hold” and potential July reduction if economic softness persists.

A Tale of Two Economies

The Canadian GDP performance starkly contrasts with U.S. results. American GDP contracted 0.2% in the quarter—the first contraction since early 2022—leaving Canada as the growth outperformer. Yet this comparative strength may prove short-lived, as the Canadian economy faces its own headwinds from weakening domestic demand and the ongoing uncertainty surrounding trade policy.

Nonfarm inventories have rebounded after declining in late 2024, and imports climbed, suggesting that much of the near-term momentum derives from frontloading activity ahead of potential tariff increases rather than underlying economic resilience. As these temporary factors fade, Canadian growth is likely to moderate significantly, keeping policymakers cautious about rushing into additional rate cuts.