EconoFACTS

November 26, 2024 | 10:15

U.S. Tariffs against Canada: The Latest Threat

Economist

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with BMO Capital Markets since 2006. He plays a key role... (Read more)

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with BMO Capital Markets since 2006. He plays a key role... (Read more)

U.S. President-elect Donald Trump said that he would impose a 25% tariff on all imports from Canada and Mexico in January, unless those countries tighten up their border with respect to drugs and illegal immigration into the U.S. While this could certainly be early posturing in order to prompt some changes in Canada and Mexico, markets are in a stir because of the severe level and potential impact.

The U.S. market accounts for roughly 75% of Canadian goods exports and nominal goods exports, in total, weigh in at about 25% of Canadian GDP (Chart 1). Indeed, Canada is a small open economy that trades heavily with the U.S.—hence the concern. There are many moving parts, and much depends on the details, but here are some high-level takeaways:

In general, we’d expected the Canadian dollar to see the biggest and most immediate market impact, extending the weakness seen in recent months. Currency adjustments can typically absorb much of the impact in a tariff setting. In this event, we see room for further depreciation from recent levels above $1.41/USD.

The ultimate size and coverage of the tariffs will determine the extent of the negative impact on growth. But, keep in mind that they would be set against a backdrop of firming domestic demand in Canada in areas like housing and consumer spending. Still, we’d be looking at a net negative growth outcome, and as an early first pass, downward revisions would counter some of the recent upward revisions recently made to the near-term growth outlook. We currently see 2.1% real GDP growth for 2025. The downward revisions would likely be felt more in the back half of the year and into 2026.

At the industry level, energy exports were C$173 billion in the latest twelve months, or nearly a third of Canadian goods exports to the U.S. (Table 1). That is the largest share of exports by a wide margin. But, one has to question the legitimacy of tariff threats on Canadian energy, when there are few obvious near-term alternatives to more than 3 million barrels per day of imports on the U.S. side. The immediate impact would be higher oil and consumer gas prices. Meantime, industrials, manufacturing and other resource exporters would be hit hard, in some cases through margin compression as Canadian firms are forced to absorb some of the impact. Autos are another difficult case where various parts cross the border multiple times before ending up in a finished product. There would clearly be some pushback at the industry level in some of these cases. Ultimately, these factors should water down the threat of a steep across-the-board tariff on all products.

At the provincial level, direct exposure to U.S. trade varies across the country (Chart 2). B.C. carries a relatively low share of goods exports in its economy, and roughly half of those exports are destined for markets outside the U.S. Ontario, on the other hand, sees goods exports weigh in at 26% of GDP, with more than 80% destined for the U.S. There is nuance because the provinces have vastly different product composition (e.g., Alberta has high U.S. exposure, but it’s mostly oil; while autos and manufacturing take up more share in Central Canada). In general, Central Canada and parts of the Atlantic region look most exposed.

For the Bank of Canada, a softer growth profile could set policy on a more dovish path, but a weaker currency and some potential inflation impact would likely keep it from deviating much from our current call. That said, if there is a tit-for-tat response on the Canadian side, we get into more of a classic supply shock, which would become more inflationary and peg interest rates higher than the current baseline. As of now, our call sees Bank of Canada policy rates falling to 2.5% by September 2025, which is more dovish than current consensus and market expectations. Set against the net risk on the tariff front, we’re comfortable with that call until further action/details emerge.

Over the medium term, any clear fracture in the trade relationship would be negative for business confidence and investment at a time when Canada is already struggling with productivity-enhancing investment. Even in the interim, uncertainty over trade policy has the potential to hold back business investment just as interest rates are coming down, pushing more of the expansion burden onto housing and interest-sensitive consumer spending—not a great outcome.

Table 1 - Canada — Goods Exports to the U.S.

Source: BMO Economics, Haver Analytics