The Canadian economy is facing the largest trade shock in the last hundred years. RBC Economics experts are forced to balance between the need to provide a clear analysis and the recognition of high uncertainty regarding the development of trade policy and the response from the Canadian authorities.
The introduction of tariffs of this level by the United States threatens a recession in Canada. According to the initial analysis, if tariffs remain in place, Canada's economic growth will slow down over the next three years, with the biggest impacts occurring in the first two years. Research by the Bank of Canada shows that a 25% tariff increase globally could lead to a 3.4–4.2 percentage point reduction in Canada's GDP. Other models predict a 6 percentage point drop in GDP, which could cause unemployment to rise by 2-3 percentage points.
Canada's response
Canada's retaliatory tariffs (25% on goods worth 155 billion CAD) are designed to provoke asymmetric pressure on the US economy. However, like any tariff measures, they will lead to lower growth rates and accelerate inflation. The main inflationary risks for Canadian consumers will be associated with an increase in the cost of imported goods.
Canada's vulnerable sectors
Canada's manufacturing sector, which accounts for about 9% of the country's GDP and 70% of trade with the United States, will take the biggest hit. In particular, the automotive industry, which is closely integrated with the United States and Mexico, will be at high risk. Canadian commodity exports are less susceptible to declining demand, as American consumers do not have readily available substitutes.
In addition to production, indirect effects will have a significant impact. For example, lower demand for cars could lead to layoffs at car factories, which in turn would hit service sectors such as restaurants and entertainment. Such "chain reactions" are difficult to accurately model, as they depend on changes in consumer sentiment.
Despite the relative stability of the US economy, the tariffs imposed will have a negative impact on its growth and inflation. The US manufacturing sector is already in a difficult situation, with a slight increase in industrial production over the past year. These tariffs could further weaken the competitiveness of American manufacturers.
Factors exacerbating the impact of tariffs
1. Duration of trade barriers. If tariffs remain in place for several months, the likelihood of a recession in Canada will increase significantly. A long-term shock will lead to structural changes, including reduced investment in industry and equipment.
2. Escalation of retaliatory measures. Further expansion of tariff restrictions in Canada, Mexico and the United States may significantly adjust economic forecasts for the worse.
Factors that can mitigate the consequences
1. The weakening of the Canadian dollar. It has already lost 7% of its value over the past year. Further easing will help reduce the price hit for American consumers and support Canada's exports.
2. Adequate fiscal policy. The Canadian government will have to balance the need to support the affected industries and the risks of rising inflation.
3. Monetary policy. The Bank of Canada is likely to continue easing monetary policy. The expected rate cut to 2% by the end of 2025 may be revised towards even greater mitigation if the tariff shock escalates into a recession.
Conclusion
The Canadian economy is in a vulnerable position, facing the largest trade shock in the last century. In the coming months, the most important variables will remain the duration of tariffs, the dynamics of retaliatory measures, and the reactions of monetary and fiscal authorities. In an environment of high uncertainty, adapting to the new economic reality will be a key challenge for Canada in the coming years.
In the long term, an important focus for Canada will be to diversify its trading partners and reduce dependence on a single large market. The development of new trade agreements and investments in competitive industries will help the country's economy adapt to changing conditions. However, the transformation process will require time and strategic decisions from both government and business. Therefore, flexibility and responsiveness in decision-making will be key factors for the sustainability of the Canadian economy in the coming years.