When US Tariff Threats Change, We Change Our Forecast

Last week we published our revised baseline forecast External link. for the Canadian economy. Given the erratic nature of economic policy south of the border, we were forced to move up the tariff impact relative to the outlook we released just prior to Christmas. Now our baseline real GDP and unemployment rate forecasts look more like our pessimistic scenario, albeit much less severe (graph 1). That’s because our baseline scenario assumes 10% tariffs will be applied across the board on non-energy imports from Canada starting April 1, compared to 25% tariffs in the pessimistic scenario.

Looking at the details of our revised real GDP outlook, there isn’t much good news to speak of (graph 2). Business investment is likely to be soft, as the uncertainty posed by on‑again, off‑again tariff threats will probably persuade business leaders to remain on the sidelines. There should be less front-loading of export demand as well given earlier tariff threats than previously assumed. All bets are off if substantial new tariffs do come into effect and North American supply chains start to be disentangled. That would add to already moribund business investment and productivity in Canada in recent years, particularly relative to the US. And while per capita consumption growth is projected to move higher as fewer permanent and non-permanent resident admissions weigh on population growth, it should still be weak. Mortgage renewals at higher interest rates, still-elevated prices and a rising unemployment rate should add to the drag on consumer confidence and overall consumption growth. Indeed, the only substantive driver of domestic demand we foresee in the coming year is from government consumption and investment, as policymakers in Canada look to support households, businesses and industries hit by tariffs External link.. But on balance, domestic demand growth shouldn’t be enough to offset the drag from trade without a helping hand from inventories.

Despite economic activity and employment likely to grow more slowly than previously anticipated, this drag on inflation won’t be enough to offset the impact of US import tariffs and Canadian retaliatory tariffs on prices. We now expect inflation could surpass 2.5% y/y in the coming months in our baseline scenario, probably eclipsing 3% in the event of an escalating trade war (graph 3). And now that we’ve had a glimpse of what goods could be subject to retaliatory tariffs, fresh and processed food imports from the States could be on the table. So too could consumer goods and intermediate inputs. That should push core goods inflation higher, alongside the prices of imported food and fuel from the US. Even without tariffs, inflation in Canada would currently be higher if not for the GST/HST holiday External link., which distorted the consumer price numbers starting in December but will be entirely in the rearview mirror by March.

Now, it’s not all bad news for the Canadian economic outlook. Reducing internal trade barriers could help to boost productivity and real GDP per capita growth in Canada. But we’ll reserve some skepticism as to whether there will be any material change in this regard. While the recent rhetoric on increasing interprovincial trade leaves room for optimism, we’ve been down this road before. As for any policy whose benefits are concentrated but whose costs are spread across a broad group of Canadians, change will be hard. We’re also skeptical when it comes to encouraging international trade diversification. Immigrant-owned businesses typically lead trade diversification, and recent immigration policy changes will work against that. And if President Trump chooses not to follow through on his policy threats, it’s tough to see Canadian businesses changing their behaviour. For these reasons, combined with likely weaker business investment overall, we haven’t yet baked higher productivity growth from these factors into our medium-term forecast. Hence, when US tariff threats change, we change our forecast.