Dashing any hopes of a last-minute reversal of his threat, US President Donald Trump signed executive orders on Feb. 1 unleashing a wrecking ball of 25% tariffs on most Canadian goods and 10% levies on energy exports to the US. The news has triggered widespread alarm among economists and fears of financial turmoil among market participants.
Trump’s tariffs take effect on Feb 04 with similar sized retaliatory taxes from Canada on US-made goods worth C$155 billion. This could inevitably push Canada into a full-blown recession and force the Bank of Canada to cut rates faster and farther than its 2% target, market analysts warn.
The fallout of the tit-for-tar tax spat could drive up Canada’s unemployment rate and further weaken its currency. Following the tariff announcement, the loonie plunged more than 1.50%, from C$1.448 on Jan 31 to C$1.472 on Feb 02. This marked the Canadian dollar’s fifth consecutive month of decline, bringing it to its weakest level since 2003.
Below is commentary from economists’ notes to clients on the fallout of the tariff war on the Canadian economy.
Trump’s Tariffs: The Most Significant Trade Shock Since the 1930s
Frances Donald, senior vice president & chief economist at Royal Bank of Canada
“This is the most significant trade shock since the Smoot-Hawley tariffs of the 1930s, which are widely blamed for exacerbating and prolonging the Great Depression. A persistent tariff of this magnitude is recessionary for Canada. If sustained, our initial analysis suggests that tariffs of this size (based on many assumptions) could wipe out Canadian growth for up to three years, with the largest impacts in the first and second years.
“Our estimates align to the Bank of Canada’s findings which simulate that a 25% increase in tariffs across the board (U.S. and global) would reduce Canadian GDP ranging from -3.4 to -4.2 percentage points. Such reductions could push Canadian unemployment rates up by between 2 to 3 percentage points. While the precise impact depends on a variety of assumptions – including monetary and fiscal policy responses – this is a significant negative shock to Canadian growth and poses a serious risks of unemployment rate increases.
“Canadian retaliatory measures (25% on C$155 billion, phased in) appear designed to asymmetrically challenge the U.S economy more than the Canadian economy. However, they will still function like tariffs do for any imposing country – by lowering growth and raising inflation on targeted goods. Tariffs are hitting the Canadian economy at a moment during which it is already struggling. Canada is still recovering from a major interest rate shock, and even as the Bank of Canada has cut interest rates by 200 basis points, the unemployment rate continues to rise, with the country is still operating with excess supply and below full capacity. Both cyclically and structurally, Canada’s economy is not well positioned to absorb a shock of this scale.
Tariffs removed within a matter of weeks are likely to create a temporary stall for Canada. However, if they extend over a matter of months (e.g. 3-6 months), Canada’s recessionary risks increase rapidly. The duration of the tariff isn’t just about the immediate shock (or recession) – the longer the tariffs last, the greater the structural damage (i.e. permanent) on the economy.”
Could Tariffs Lead to a Recession?
Douglas Porter, CFA, chief economist at BMO Economics
“Trump’s tariff hammer will come down hard on Canada’s economy. If the announced tariffs remained in place for one year, the economy would face the risk of a modest recession. A couple quarters of contraction are well within the realm of possibility. With little confidence given the lack of historical precedent, we estimate that the tariffs will reduce real GDP growth by about 2 percentage points to roughly zero in 2025. This reflects reduced demand for Canadian exports to the U.S. (which account for about a fifth of GDP), disrupted supply chains impeding business activity and consumption, and heightened uncertainty that reduces business investment.
“It also reflects a reduction in domestic demand due to higher prices stemming from retaliatory tariffs and a weaker Canadian dollar. The estimated growth hit is a bit lighter than the Bank of Canada’s recent scenario (it called for about a 2.5 percentage points reduction in GDP growth for the first year), due to the lesser 10% tariff on energy products, as well as the fact that Canada’s retaliation is measured. However, we recognize the difficulty in modelling such an extreme event, and certain sectors may not behave in a predictable pattern— [such as] the highly integrated auto industry.
“CPI inflation is expected to rise less than one percentage point this year from the current 1.8% rate in December. But given growing slack in the economy and a likely more-than-one percentage point increase in the unemployment rate to around 8%, inflation pressures should remain subdued, allowing for some moderation in 2026. Partly limiting the economic pain will be a weaker currency, lower interest rates, and an expected government relief program for jobless workers and affected businesses. These supports, along with the assumed revoking of tariffs after one year, should lead to a modest recovery in real GDP growth to about 1% in 2026.
“From a sectoral lens, a wide range of Canadian industries derive at least half of their revenue from U.S. exports. Near the top of the list is motor vehicles, but others with high exposure include auto parts, clothing, wood products, chemicals, medicines, rubber, iron and steel, aluminum, machinery, computers, and electrical equipment. While the oil industry has very high exposure, we assume the 10% tariff will have little dampening effect on U.S. demand given a combination of a weaker loonie, Canadian producer price cuts, and U.S. refinery cost absorption.”
Brace For More Tariffs Damage to the Canadian Dollar
TD Economics analysts, led by Beata Caranci, SVP & chief economist
“The lower [10%] tariff rate on Canadian energy resources is likely because the administration is sensitive to risks related to price escalation at the pumps, where it is highly observable and carries immediate impacts to household budgets. At 10%, there is likely a gamble that U.S. refiners could absorb some (or all) the impact via profit margins. Importantly, Trump has indicated that should Canada retaliate, the U.S. can increase or expand the scope of duties.
“Given the U.S. ‘retaliation’ clause to respond to Canada’s retaliation… brace for a further escalation. Common sense, game theory dictates the only ‘reasonable’ off-ramp to this tit-for-tat spiral is diplomatic negotiations or be prepared for all parties to end up on a permanently lower economic trajectory. Unfortunately, the key unknown, duration, is the most important of the four measures [depth, breadth, retaliation and duration] in determining the economic and financial market trajectory on both sides of the border.
“We expect a sharp negative reaction in the loonie and North American equity markets come Monday. We would not be surprised to see the currency flirt with at least 65 U.S. cents in relatively short order, with further downside risk as duration builds on tariffs.
“[The Bank of Canada] will be closely monitoring the speed of transmission [of the impact of tariffs] to inflation, inflation expectations, and the relative deterioration in the economy. Which of these forces ultimately dominate will inform the policy response. For Canada’s economy, the situation is worse. Our calculations show if these tariffs are sustained for 5 to 6 months, it would officially tip the domestic economy into recession, albeit a relatively shallow one at that point. Further duration would naturally deepen the contraction.”
The Inflation Risk From Trump’s Tariffs
Tu Nguyen, economist RSM Canada
“Trump’s tariffs, and Canada’s response to add a 25% tariff on C$155 billion of U.S. imports beginning Tuesday, would send Canada into a recession this year, after the country reached a soft landing in 2024. Job losses should be expected across industries, from manufacturing to tourism to transportation. Higher prices decrease demand, which means aggregate demand for goods across the U.S. and Canada would drop — leading to fewer jobs.
“For Canadian households, this means an increase in prices of multiple consumer goods, including groceries, appliances and especially vehicles. Prices of perishable goods such as fruits and vegetables are likely to jump as early as this coming week, given that they cannot be stockpiled in advance. Although the price of goods like appliances and cars would take longer to increase, they will inevitably rise.
“Provincial governments are also implementing non-tariff responses to the U.S. measures, such as Nova Scotia’s [and more recently, Ontario’s] removal of all U.S. alcoholic products from its shelves. Canadians could expect to see fewer U.S.-made products in store.
“The depreciation of the Canadian dollar could mitigate the prices of exports for U.S. importers, but this exacerbates the pain for Canadian businesses and consumers. Since Trump’s executive order includes a clause that U.S. tariffs on Canadian goods could increase if Canada retaliates, this could be just the beginning of a trade war.”
What Could Tariffs Mean for the Bank of Canada?
Avery Shenfeld, chief economist at CIBC
“The US has launched the first salvos in what could be an all-out trade war or merely a shorter-lived skirmish with Canada and Mexico. This is a shock, but there’s nothing to be in awe about here. It will entail a significant economic hit to what we’ve always thought was America’s close ally to its north, and will serve to raise prices and slow growth in the US itself. But the announcement has by no means cleared up the uncertainty over what comes next if Canada addresses Trump’s concerns over migrants and drug flows across the border. We also can’t completely rule out a court challenge in the US, since we understand that the act the President has used to invoke these measures has been used for sanctions rather than tariffs in the past.
“In that [a drawn out two-way tariff war] outcome, the level of real GDP could be 5% lower than in our prior forecast by the end of 2026, and while that outcome could be cushioned with a sufficient monetary and fiscal response (including a recycling of tariff revenue), the level of GDP at full employment will be permanently on a weaker path due to the reduced two-way trade.
“But at this point, we’re not ready to give up on the ability of Canada and its allies in the US and the business sector to reach a more favorable resolution. For our base case economic forecast, we’re assuming that the tariff on Canada, and the retaliatory tariffs on the US, are lifted at the end of Q2.
“While we would favor a monetary policy easing as part of the initial response, our existing call for a 2.25% overnight rate by the end of Q2 may be all we see from the Bank of Canada if the tariffs end at that point. The Governor appeared to be concerned about feeding into inflation expectations with a more aggressive stance. Should tariffs persist beyond Q2, recession-style job losses and the reduction in spending power would put enough downward pressure on prices to cancel out the initial upside, and thereby leave the Bank of Canada an easy decision to ease rates more aggressively. It’s hard to believe that inflation expectations would shoot higher with significant slack in the economy and so much uncertainty looming over Canada’s long-run growth prospects. It would take a lot of fiscal stimulus to substitute for monetary policy, and a combination of accommodative rates and targeted fiscal support would likely be part of the response.”
The Impact of Tariffs on Canada’s GDP
Paul Ashworth, chief North America economist at Capital Economics
“[It] is just the first strike in what could become a very destructive global trade war. Since exports to the US account for around 20% of their GDP, today’s tariffs could plunge both the Canadian and Mexican economies into recession later this year. The resulting surge in US inflation from these tariffs and other futures measures is going to come even faster and be larger than we initially expected. Under those circumstances, the window for the [US] Fed to resume cutting interest rates at any point over the next 12 to 18 months just slammed shut.”
Stéfane Marion, chief economist and strategist at National Bank of Canada
“We now forecast GDP growth of 0.4% in 2025, down from our previous estimate of 1.4%, and 0.9% in 2026, compared to the previous baseline projection of 1.5%. The economic slowdown will be driven by weaker exports and investment, slower consumer spending, tighter financial conditions, leading to higher capital costs for businesses and a negative wealth effect for households.
“As economic conditions weaken, the unemployment rate is now projected to average 7.4% in 2025, up from 7.0% previously. A further increase to 7.6% is expected in 2026, compared to the previous forecast of 6.7%. While domestic inflationary pressures will be more subdued due to weaker demand, overall inflation is expected to be slightly higher, driven by tariffs, which will raise import costs, [and] currency depreciation, making foreign goods more expensive. We now expect CPI inflation to rise by 2.3% in 2025 (compared to 2.2% previously) and by 2.3% in 2026 (up from 2.1%).
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