The U.S. trade war has already hit the Canadian economy, but the tariff path ahead could still lead to anything from modestly slower growth to a recession, a new report says. Looking at three possible tariff paths, the report by BMO said Monday that even the more optimistic scenario of tariffs staying at the roughly 7% level could mean a 1.5% drop in long-term GDP, compared with the outlook at the start of the year.
A worst-case scenario with a 35% tariff across the board could mean a moderate recession in the short-term and 5% shaved off long-term economic growth, while a middle scenario of tariffs averaging 15%, similar to other trading partners like Europe or Japan, could mean significantly slower growth in the near-term and 2.5% cut to growth.
‘Muddle through’ scenario expected as Canada-U.S. trade talks continue
BMO chief economist Douglas Porter said the most likely path seems to be a continuation of current tariff rates. “We call it the ‘muddle through’ scenario,” Porter said. “We do believe that something close to the average tariff on Canada is about what we’re going to be left with.” He said there could be some changes in industry-specific tariffs, but that change could go both ways.
Prime Minister Mark Carney is to meet with U.S. President Donald Trump on Tuesday. The pair are expected to talk trade and security as the ongoing tariff dispute shows few public signs of progress.
“We are hopeful that one of the things that we might hear from this week’s meeting between the prime minister and the president is some sort of relief on steel tariffs,” Porter said. “But on the other hand, it could be replaced with something else down the line, because we know they have a long list of sectoral tariffs that the administration is looking at.”
CUSMA’s future looms as trade talks signal potential renegotiations
The bulk of Canadian goods continue to enter the U.S. tariff-free thanks to an exemption under the Canada-U.S.-Mexico trade agreement; however, the U.S. has continued to expand its use of sector-specific tariffs, including the recent addition of fresh levies on furniture, pharmaceuticals, and lumber. Goods that don’t fall under the trade deal are subject to 35% tariffs, hence the reference point in the report’s worst-case scenario.
The future of CUSMA is the big question lurking in the background of trade talks, as it’s set for review next year. The extent of those negotiations are still not clear, but a key signal of how much change could be ahead will be if Trump seeks Trade Promotion Authority from Congress, allowing all aspects of the deal to be renegotiated, the report noted.
Canada uses monetary and fiscal tools to cushion impact of U.S. tariffs
To soften the hit from tariffs, Canada can respond with easier monetary policy, fiscal stimulus, and reoriented trade policies, which the Bank of Canada and federal government have already started doing, Porter said. “Both have to some extent already responded, and that’s one of the reasons why the economy has held up a bit better than we and others were thinking earlier this year.”
The Bank of Canada dropped its key rate by a quarter percentage point to 2.5% in September, with another cut expected by financial markets before the end of the year. The cut happened as lower oil prices have helped soften inflation fears, while economic indicators suggested the Canadian economy could use the help.
Real GDP declined 1.6% on an annualized basis in the second quarter. Statistics Canada has measured July growth of 0.2%, but preliminary data for August suggested no growth.
While economic growth has been muted, it hasn’t stopped Canada’s stock market from trading around all-time highs, pointing to the targeted hit of tariffs so far, Porter said. “So far, the effect of the trade war is very narrow on Canada. It’s the steel and aluminum sector, the auto sector, copper, and now lumber. And aside from that, we’ve mostly, not entirely, but mostly been free of tariffs, as long as you’re USMCA compliant.”
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