The Decisive | Season 3 Ep.9 - Economic Angst: Canada's Faceoff on Trade

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Kristin Hallam:
You're listening to the Decisive Podcast, insights and analysis to empower confident decision-making. Welcome to the Decisive Podcast, brought to you by S&P Global Market Intelligence. I'm your host, Kristin Hallam. In this episode, we're discussing Canada's economy with economics director Arlene Kish, who is speaking with us from Toronto. Arlene, welcome back to the podcast. It is great to have you on the Decisive.

Arlene Kish:
Great to be back, Kristin. These are very interesting times, causing businesses to rethink strategies and supply chains and consumers to reconsider how they spend their disposable income. There's a lot to consider right now.

Kristin Hallam:
Interesting times indeed. So, Arlene, let's tackle tariffs first since that is the hot topic. Let's start with a little history lesson. What happened in the first Trump administration with tariffs on Canadian goods?

Arlene Kish:
Well, we have to remember that the NAFTA agreement was up for renewal, and President Trump obviously did not like the terms of the deal. Initially, Trump imposed a 20% tariff on softwood lumber, which has long been a disputed commodity between our two countries. Then, a year later, a 25% tariff on steel and a 10% tariff on aluminum was announced.

Once NAFTA was renegotiated as the USMCA, tariffs weren’t removed until the trade agreement became official. Following that, overall trade in steel and aluminum declined sharply once the tariffs were imposed. While there was a hit to trade, it wasn’t severe given the share of those traded goods between the U.S. and Canada.

Kristin Hallam:
And how did Canada respond at that time, Arlene?

Arlene Kish:
We responded with counter-tariffs on steel and aluminum, but we also imposed tariffs on a long list of strategic and targeted items directed at Republican and border states. In total, these tariffs amounted to about $16.6 billion and included items like Harley-Davidson motorcycles, Florida orange juice, bourbon, maple syrup, shaving products, and even ketchup.

Kristin Hallam:
Ketchup? I didn’t have that on my bingo card. So, Arlene, what are you assuming about U.S. tariffs on Canadian goods in Trump’s second term? What’s in your model right now?

Arlene Kish:
We’ve been having big discussions with our colleagues, especially our U.S. counterparts. Right now, we're assuming a 10% U.S. tariff on Canadian export goods, which is unchanged from our initial call back in December when President Trump made the announcement. The 25% U.S. tariff on steel and aluminum is also included in our latest forecast.

In response, we are assuming that Canada’s counter-tariffs would be of the same magnitude—10%. However, we are not including a tariff on energy, as government officials want to limit the economic downturn, given that energy is our biggest export. Avoiding an energy tariff would also help limit inflationary pressure on Canadians.

Kristin Hallam:
And what would the impact be on the Canadian economy if these 25% tariffs go forward? Under what circumstances could tariffs cause a recession?

Arlene Kish:
Our forecast already shows that the Canadian economy would take a hit. Under our assumption of a 10% tariff and counter-tariff, real GDP growth would decline by about half a percentage point this year and next. Before the tariff announcement, we expected real GDP growth to be about 2%, but now it’s down to 1.5% for this year. Next year, growth was pegged at 2.3%, but we’ve lowered it to 1.7%.

The main drivers of near-term growth were household and government consumption. Investment spending was expected to rebound this year, largely due to gains in residential investment amid low borrowing costs and pent-up housing demand from a population surge. Net trade was initially expected to add to growth, but the outlook for industrial production is now more bleak due to uncertainty around trade.

Our modeling team has also run scenario analyses assuming a 25% tariff on Canada. This includes tariffs at varying rates on different countries and regions. The impact results in reduced global demand. While this is not our official forecast, it's a valuable exercise to understand the longer-term effects of a permanent 25% tariff on Canada's economy.

The biggest hit to annual real GDP growth would come in 2026 and 2027, across all sectors. Real GDP levels would not return to our November baseline forecast, remaining about 2.9% below it ten years out. This means a permanent loss in economic activity, with the trade sector being the most negatively affected. Under this scenario, real exports would be 6.5% lower than our baseline forecast, while real imports would decline by 3.4%, and total fixed investment would drop by 3.2%.

Tariffs wouldn’t cause a sudden economic shock like COVID-19, but they would structurally change how the economy operates. Canada and other affected countries would ultimately be worse off.

Kristin Hallam:
Alright. Thanks, Arlene, especially for distinguishing between forecasts and scenario analyses. So, what types of Canadian goods are likely to be targeted? Should I stock up on maple syrup and Crown Royal whiskey?

Arlene Kish:
Absolutely! Great question, Kristin. It might be a good idea to stock up on Canadian goods while you can. Based on what President Trump has announced, we should expect all Canadian goods to be targeted and subject to tariffs. We’ll have to wait and see what is officially announced in the coming weeks. The next deadline for Canada-specific tariffs is March 4, while the 25% tariffs on steel and aluminum are planned for March 12.

Since the U.S. imports most of these metals from Canada, it's likely that American prices for autos, appliances, cans, and other metal-dependent goods will increase as costs are passed on to consumers. If Canada responds in kind, prices here at home will rise as well.

Just to give you an idea, using the household consumption price deflator as a proxy for inflation, if 25% tariffs were imposed, price increases in Canada would accelerate. The biggest price inflation jump relative to baseline would occur in 2026, increasing by about 0.7 percentage points—double the rate initially estimated for that year. For example, household spending prices were anticipated to rise by 0.8% in 2026, but with tariffs, they would increase by 1.5%. So just when we were expecting price pressures to ease, tariffs would erase those gains, adding more strain on household budgets.

Kristin Hallam:
Wow, doubling. I’m glad you included those numbers, Arlene—they really illustrate the impact. Now, what do you expect from Canada in terms of a response to U.S. tariffs?

Arlene Kish:
The Canadian government has been clear that it will match U.S. tariffs dollar-for-dollar. Earlier this month, before President Trump announced a pause on tariffs, Canada provided an initial list of U.S. exports worth about $30 billion that would be subject to counter-tariffs. These included food, tobacco products, clothing and footwear, toiletries, wood and paper products, gardening supplies, household items, and appliances.

The intent behind this list was to limit harm to the Canadian economy and consumers. However, a second, much larger set of tariffs is expected, targeting items such as autos and energy, which would cause a bigger economic hit on both sides of the border.

One interesting example is alcohol. The Liquor Control Board of Ontario (LCBO) is the world's largest dollar-value alcohol purchaser. Because it makes significant purchases of high-priced alcohol, tariffs could significantly impact the U.S. distilling industry.

Kristin Hallam:
Wow. I did not know that. The largest dollar value purchaser of alcohol in the world is the Liquor Control Board of Ontario. So other than alcohol, what US industries or products might experience supply chain disruption, higher costs, or other impacts from Canadian tariffs?

Arlene Kish:
Well, Kristin, the Canadian government has stated that everything is on the table. And we have to look at our overall trade outlook and the value in what is being traded with the US. Now the current share of the Canadian exports to the US is about 76%. They get all of our export. The top Canadian export item to the US is our energy export. That's because many border states and other regions are heavily reliant on Canadian energy through well-established pipelines. We export about 4,000,000 barrels of oil per day. We also export gasoline, natural gas, and electricity where infrastructure does not exist within the US to service port states.

Now a tariff on gasoline would drive up the price of fuel at the pump, for example, and some people estimate that it would be up to 75¢ additional to the price of gasoline per gallon. This increase in gas prices would run counter to Trump's campaign election promise, and this is probably why Trump revised his broad-based 25% tariff on everything from Canada to imposing a smaller tariff on energy at 10%. Yet when you look at our overall trade balances with the US and Canada, our energy trade is what's contributing to Canada's trade surplus with the US. If we were to remove energy, the US has a trade surplus with Canada, and that's something that's existed since 2008.

US producers and refineries in distribution channels cannot just flip a switch to pump more US oil. Therefore, US states importing Canadian energy will feel the impact immediately of tariffs. But as always, Canada will continue to be a reliable, low-price, and safe resource of energy to the US.

Kristin Hallam:
Wow. 75¢ addition per gallon at the pump. As my husband will tell you, Arlene, I notice when it goes up 3¢, let alone 75¢.

Arlene Kish:
Exactly. It will be possible.

Kristin Hallam:
Yes. Now tariffs aren't the only uncertainty facing the Canadian economy. As you know so well, Arlene, Canada is experiencing a period of political uncertainty right now. And I know you're not a political analyst, but could you give us the broad strokes of what the political situation is in Canada for our listeners who may not be up to speed on that?

Arlene Kish:
As you know, Canada has its own domestic issues when it comes to politics. Federally, since last summer, there's been a growing discourse within the federal Liberal Party with elected members leaving or making announcements that they would not seek reelection during our mandated fall election.

During the holidays, Prime Minister Justin Trudeau announced that he would be stepping down as prime minister and Liberal Party leader. He's asked the governor general to borrow government so the Liberals can have time for a convention and pick a new leader, which is underway right now. Hence, you would also have a new prime minister.

Now there are currently four possible candidates in the running, but the top two include former Bank of Canada and Bank of England governor Mark Carney and former finance minister and deputy prime minister, Chrystia Freeland. Before Justin Trudeau announced that he was stepping down, polling results showed that Pierre Poilievre, leader of the Conservative Party, would have a hefty lead over the Liberals by at least 23 points. A more recent poll showed that if Mark Carney were to become Liberal leader, that favorable gap would close significantly to about just eight points.

Therefore, Canadians are growing more discontented with Prime Minister Trudeau and his policies. So in about a month's time, when parliament is back in session, either the Conservatives or the NDP would call a non-confidence vote, which would then trigger an election, probably in the late spring. But in the meantime, negotiations and talks with the US continue to hammer out a deal regarding tariffs, and every political party will be firming up their policies by the time the election comes around.

Kristin Hallam:
Alright. Thanks for that overview. That's really helpful context. And what does that political uncertainty mean for the economy? I'm specifically thinking about business investment, but I'm guessing it's not limited to just that.

Arlene Kish:
You are very correct. It isn't limited to investment, but it is one of the top concerns, as it will be vital to keeping the economy chugging along. Though what we've seen in the past for many quarters, the Bank of Canada business outlook surveys have shown that firms, on balance, are reluctant to spend on investment or expand payrolls.

A big driver of those responses was the unknowns regarding the outcome of the US election and the timing and depth of the monetary policy easing cycle. Now in the latest business survey, results show that investment spending is advancing within the energy industry, but not much elsewhere. So this high degree of uncertainty will always slow or pause business investment.

Some of the hot topics in the election include removing the carbon tax. No political party favors this tax anymore, at least for consumers, but we don't know if there are going to be changes or revisions or what it would be replaced with.

There's also talk about reversing the capital gains tax increase that was announced in the 2024 budget, which was to go into effect in June but has now been delayed until January 2026. However, based on what's happening, that'll probably be a non-issue after a federal election.

Another key issue is housing policy. Parties and candidates are beginning to announce their plans to address the shortage of affordable housing, and we'll have a better idea later on. Overall, government financial supports or changes to fiscal policies are important to provide some sense of stability that the private sector can't yet provide.

We also need to consider interprovincial trade barriers. This has been a long-standing issue, but now there is political will for some type of resolution. If provinces recognize labor accreditations, labor could move quickly across Canada, filling shortages, especially for skilled labor. Similarly, removing transport restrictions between provinces could help boost trade and reduce reliance on foreign markets.

Kristin Hallam:
That is really interesting. I didn't realize that so many interprovincial barriers existed in terms of trade throughout Canada. Very interesting indeed. And I'm also curious about what BC wines taste like.

Arlene Kish:
It's all good.

Kristin Hallam:
It's all good.

Arlene Kish:
All Canadian wine is all good.

Kristin Hallam:
Yeah. Maybe that'll be a future podcast episode. We'll have the wine-tasting episode.

So with all of this in mind, Arlene, what monetary policy actions are you expecting from the Bank of Canada?

Arlene Kish:
Well, overall, the Bank of Canada is likely done with large interest rate cuts. Inflation has been near 2%, and the bank is focused on excess capacity in the economy and the labor market. Given the probable trade policy impacts and potential economic slowdown, we expect additional rate cuts, with the overnight rate probably hitting about 2.25% this year.

Kristin Hallam:
Alright. And what indicators are you watching that might tip the balance, Arlene?

Arlene Kish:
Absolutely. I'll be looking at Canada's manufacturing indicator, business activity, labor market trends, and consumer sentiment, especially regarding US goods. If tariffs significantly impact trade, we could see job losses and economic shifts.

Kristin Hallam:
Lots to watch there for sure. Now, Arlene, I could keep talking to you about this, but it's time to wrap up our conversation. Any final thoughts for our listeners?

Arlene Kish:
Expect the unexpected when it comes to tariffs and inflationary pressures. Prices could rise in unexpected ways, and consumers should be prepared.

Kristin Hallam:
Alright. You heard it here. Expect the unexpected, and watch those lobster prices.

Arlene Kish:
That's right.

Kristin Hallam:
Well, thank you so much, Arlene, for taking the time to share your insights with us today. That wraps up this episode of the Decisive podcast. Until next time.

Arlene Kish:
Take care.

Kristin Hallam:
Thank you for listening to the Decisive podcast from S&P Global. Please subscribe and join us for next week's episode. Until then, stay curious and stay informed.