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March 28, 2025 | 14:16
The Trade War Revs
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The Trade War RevsThe Trump Administration has announced tariffs on automobiles and parts, with broader reciprocal tariffs to be revealed on April 2. America’s global trade war is escalating with Canada’s economy in the line of fire. |
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On March 26, President Trump signed a Proclamation imposing an additional 25% tariff on all cars, light trucks, and some auto parts, made outside the United States. It was imposed under Section 232 of the Trade Expansion Act of 1962, based on a trade investigation conducted during the first Trump Administration (February 2019). The investigation concluded that elevated imports of automobiles and parts were a threat to national security, but the President did not act at the time. He’s acting now. The details are as follows:
Implications for the U.S. economy…While the U.S. is a major producer of vehicles, it also imported over 8 million vehicles last year (US$243 billion worth) (Table 1). Hence, the newly announced tariffs will have a sudden and sharp impact on pricing in the U.S. auto industry. New vehicle inventory levels are healthy leading into this latest trade shock at around 3 months of supply, but there are significant differences across brands, and prices are likely to rise prior to the existing inventory being sold. With average transaction prices already running at around US$45,000, consumers could see new vehicle prices increase by thousands of dollars if these tariffs remain in place. |
Earlier this month, we downgraded our forecast for the U.S. economy, reflecting the impact of tariffs. Though subject to change, our working assumption has been that the economy would be impacted by the rough tariff equivalent of 20% on China, 25% on Mexico and 25% on Canada except for 10% on Canadian energy and critical minerals, and the duties would remain in place for a year. For 2025, this led us to lower real GDP growth by 0.4 ppts to 1.8%, on average, and lift CPI inflation by 0.4 ppts to 3.0%. The removal of tariffs on USMCA-compliant goods (and reduction in potash duties to 10% from 25%) pointed to a potential forecast upgrade, but we reckoned other tariffs to come would still push up the average tariff rate to above where we assumed it would be. For example, the 25% levy on steel and aluminum could clip GDP growth by a tenth this year, and we have subsequently reduced our 2025 GDP growth call to 1.7%. |
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Our first pass at the impact of the auto tariffs alone on U.S. growth and inflation this year suggests the former could slow by 0.2 ppts while the latter could rise by up to 0.4 ppts. Assuming partial retaliation by other countries and some modest rise in the dollar, U.S. exports of light vehicles and parts (tallying US$132 billion in 2024, or 0.5% of GDP) will decline. Disruptions to supply chains as U.S. automakers seek domestic suppliers will also weigh, with some offset from increased domestic production. We also lowered our forecast for U.S. auto sales by 5% this year to 15.0 million due to an expected 10% increase in prices. While some buyers may simply downscale their purchases, others are likely to postpone or forgo them. The estimated inflation increase assumes an 18% rise in the average tariff on vehicles (less than the headline 25% increase due to no duties on U.S. vehicle content), applied to the US$400 billion of U.S. light vehicles and parts that were imported in 2024. A firmer dollar limits the direct inflation rise from tariffs to 0.1%-0.2%. But domestic vehicle prices are also likely to rise due to less competition and increased demand rubbing up against eventual capacity limits. U.S. car prices—excluding the direct effect from tariffs—could increase by 5%. With consumers spending nearly 4% of their budget on new and used motor vehicles and parts, this could lift inflation by an additional 0.2 ppts. While more plants may be built to increase capacity, staffing them could be an issue. In the announcement, President Trump emphasized that this latest action will foster growth in the domestic auto sector. However, it remains unclear whether automakers will immediately pivot more production stateside. Auto plants typically take several years to build and require anywhere from hundreds of millions to billions of dollars of capital investment. Capital craves certainty, and the current operating environment makes it unclear what the market access rules within the North American auto industry will look like for the next week, let alone the next decade—the latter of which tends to be closer to the timeline that these crucial investment decisions are made. The latest announcement is more likely to encourage firms to engage in hoard-and-hold behaviour as they wait for more certainty on the future tariff landscape. Implications for the Canadian economy…Automotive trade represents a much larger share of Canadian GDP, and most Canadian production is sent to the United States (Table 2). The automotive supply chains have been integrated between the two countries since 1965 and Canadian assembly plants are sized to supply the North American market, so it’s not easy to rescale them to produce only for the domestic market. Canadians could also face higher new vehicle prices under these tariffs as many popular models are made in the U.S. and could be subject to retaliatory tariffs. As it stands now, Canada is a net importer of finished vehicles, with auto production running at a roughly 1.4 million annualized pace versus new unit sales of just under 1.9 million. |
Adding to the uncertainty for Canada is that, as part of the USMCA agreement, Canada signed a side-letter with the U.S. specifically exempting the Canadian industry from future 232 tariffs. In that additional agreement, up to 2.6 million passenger vehicles, an unlimited number of light trucks, and US$32 billion worth of auto parts all on an annual basis would be exempt from tariffs. Those would more than cover current trade with the U.S., though it’s unclear what recourse Canada would have at its disposal to invoke the side-letter. |
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Again, earlier this month, we sharply downgraded our forecast for the Canadian economy reflecting the impact of U.S. tariffs, with the same working assumption as stateside but also including retaliatory tariffs on $155 billion worth of imports from the U.S. For 2025, this led us to lower real GDP growth by 1.3 ppts to 0.5%, on average, and lift CPI inflation by 0.6 ppts to 2.6%. While that was looking somewhat hawkish as USMCA-compliant goods were exempted from tariffs, as in the U.S. case, the 25% levy on steel and aluminum (which alone could lower Canadian real GDP growth by 0.2 ppts this year), and now automobiles and parts, are skating our forecast back onside. Looking at automotive tariffs alone, vehicles and parts account for a hefty 20% of Canadian non-energy exports to the U.S., or nearly 3% of GDP. The indirect spinoff effects through the supply chain and potential losses of well-paying jobs magnify the impact. We judge these auto tariffs alone could carve 0.5 ppts from Canadian GDP growth this year—but much depends on factors like the currency and the U.S. price response. Meantime, some upward pressure on prices and weaker macroeconomic conditions could cut auto sales volumes by roughly 10%, although there could be support from a shift to domestically-produced vehicles and any fiscal stimulus that gets rolled out. Canada’s response to this announcement is pending, and we are holding off considering further adjustments to our forecast until we get those specifics. Meanwhile, Ontario would take the biggest hit from this round of tariff action given the province’s direct auto-sector exposure—motor vehicles & parts exports to the U.S. weigh in at almost 6% of GDP. Our current outlook already incorporates a disproportionately hard hit in Ontario, with real GDP growth expected at -0.2% in 2025 versus +0.8% for the rest of Canada. Ontario has also yet to table a FY25/26 budget, and a weaker economic outlook under these tariffs would have a meaningful revenue impact. At the same time, there will be a big role for the province to play with respect to fiscal support/stimulus, in addition to any federal measures. The good news is that Ontario comes into this in relatively solid fiscal shape. The tariff cavalcade continues…The Administration is saying that reciprocal tariffs will be announced on April 2 and focused on the “Dirty 15” (for now). The official list hasn’t been published, but we presume it’s the 15 largest contributors to the deficit (Table 3). Note that more than two-thirds of the total trade shortfall is owing to China, the EU, Mexico and Vietnam. Some commentators have suggested lists that include other members of the G20. However, the U.S. has trade surpluses with the likes of the UK, Brazil, Australia and Saudi Arabia, and deficits with Russia and Turkey run in the $1-to-$2 billion range. It’s also unclear how the reciprocal tariffs will be crafted, but we reckon they will partially reflect the fact that all of America’s major trading partners have a value-added tax, and the U.S. does not. A VAT is a tax on domestic final consumption that treats both domestically produced goods and imports the same. In America, consumer spending is taxed at the state and local level, not at the federal level. Administration officials view this as an unfair burden on U.S. export sales in these countries. |
After reciprocal tariffs, there’s a slate of sectoral and other duties pending. Section 232 investigations are currently underway for copper and lumber, which will likely conclude that elevated imports are a threat to national security and tariffs are warranted. (New lumber duties will be particularly stinging for Canada.) And the President has repeatedly promised tariffs on semiconductors and pharmaceuticals. Two other issues on the tariff docket include just-announced 25% levies on countries that import oil from Venezuela along with the consideration of sharply higher U.S. port fees for Chinese-made ships. Beyond reciprocal tariffs, there’s lots of uncertainty about which tariffs will be coming next and how long any of them will remain in place. Given the uncertainty, we’re bracing for more adjustments to our economic forecasts in the months ahead. With files from Sal Guatieri and Robert Kavcic |
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