Overview
On February 1, U.S. President Trump signed an executive order imposing a 25% tariff on all non-energy imports from Canada and a 10% tariff on energy imports (effective February 4). In separate executive orders, a 25% tariff was levied on all imports from Mexico and a 10% tariff was put on all imports from China. These rates are in addition to any tariffs or duties already charged.
He invoked the International Emergency Economic Powers Act (IEEPA) to apply these tariffs. After declaring a national emergency at the southern border (January 20) due to “the influx of illegal aliens and illicit drugs”, the President expanded this to cover “the public health crisis of deaths due to the use of fentanyl and other illicit drugs”. And, specifically, “the failure of Canada to do more to arrest, seize, detain, or otherwise intercept DTOs [drug trafficking organizations], other drug and human traffickers, criminals at large, and drugs”. Furthermore, this failure by Canada “constitutes an unusual and extraordinary threat… to the national security and foreign policy of the United States”.
The order also said: “Should Canada retaliate… the President may increase or expand in scope the duties imposed under this order”. Canada subsequently announced 25% retaliatory tariffs on C$155 bln worth of imports from the U.S.: $30 bln effective February 4 and the remaining $125 bln after 21 days. Several provinces have also announced non-tariff measures.
It’s uncertain whether: 1) the U.S. will retaliate for Canada’s retaliation; 2) the Administration will heed the calls from U.S. businesses for exemptions (the aluminum industry is already on record); and 3) if the executive order will survive legal challenges, or when the President will be satisfied that Canada’s 'failure' has been remedied. However, by April 1, there will be three reports delivered to the President (under the America First Trade Policy memorandum) that should be full of tariff recommendations backed by investigations (or soon-to-be), setting the stage for more Section 201 (safeguard), Section 232 (national security) and Section 301 (unfair trade practices) tariffs. In consequence, tariffs on Canada and other countries could be around for a while.
Given this backdrop, we are adjusting our forecasts, as outlined below. This is clearly a fluid situation, and further adjustments may be required in the weeks ahead, as more information comes to light in terms of Canada's fiscal response, as well as any potential U.S. countermeasures, or even a possible off-ramp for the tariffs. For now, we are incorporating the information on hand, and assuming that the tariffs will be in place for a year.
Economic Impact on Canada ...
Trump’s tariff hammer will come down hard on Canada’s economy. If the announced tariffs remain 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 ppts 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 ppts 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—e.g., the highly integrated auto industry.
CPI inflation is expected to rise less than one ppt this year from the current 1.8% rate in December. But given growing slack in the economy and a likely more-thanone ppt 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. In agriculture, tobacco, greenhouses, sugar, and seafood stand out. 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. The housing market recovery in Canada, as gradual as we expected it to be in the absence of tariffs, could be dampened this year by the confidence-sapping trade war, before resuming in 2026 on lower mortgage rates.
It is somewhat encouraging that the U.S. executive order keeps the door open for revoking the tariffs if the said national emergency “crisis is alleviated”. In the event the tariffs prove short-lived, we would unwind the downward revisions to growth. However, the order also warns that the President could increase tariffs further in response to retaliatory actions, which would raise the risk of a deeper economic downturn. The potential long-term damage to Canada’s economy cannot be dismissed, either. Many businesses will increase production on the other side of the border to avoid tariffs. The uncertainty alone about further protectionism could put a chill on business investment for years, which is why the government’s response should also be directed at encouraging productivity-enhancing investment. This was already a necessity before tariffs given the new U.S. administration’s planned pro-business policies, including corporate tax cuts and lighter regulations.
... and the Provinces
Direct exposure to U.S. trade varies across the country, and so will the impact. B.C. carries a relatively low share of goods exports in its economy, and roughly half of those are destined for markets outside the U.S, but some industries (e.g., forestry) will come under duress. Alberta, Saskatchewan and New Brunswick, because of hefty energy exports, carry the largest exposure (exports to the U.S. are 25%- to-36% of GDP); but, the lighter 10% tariff on such products, and the assumption that a portion will be passed to the U.S. consumer, leaves the impact to run smaller in these provinces—at least in the short run.
Non-energy U.S. export exposure is highest throughout Central Canada. In Ontario, for example, U.S. goods exports top 17% of GDP with a wide range of industries exposed (e.g., autos, machinery, metals and consumer goods). Quebec’s industrial metals and manufactured goods will be vulnerable, as will Manitoba’s diverse manufacturing base. Atlantic Canada is susceptible because of a few highly-concentrated industries, even if the broad economic impact appears smaller—think the Newfoundland & Labrador fishery, and PEI packaged food goods.
All told, we expect the economic impact to hit hardest in Ontario and the rest of Central Canada; significantly impacting some concentrated industries in Atlantic Canada and B.C., while dealing a lesser immediate blow in oil-producing provinces.
Rates and the CAD
The Bank of Canada’s rate cut last week was partly portrayed as a risk management move compelled by the rising risk of U.S. tariffs. With that risk now being realized, we reckon the Bank will lean against the expected significant economic slowdown and steeply escalating risk of recession along with associated disinflationary pressures. However, there will be a measure of caution in the policy easing, with inflationary pressures simultaneously prodded by retaliatory tariffs and Canadian dollar depreciation. Previously, we projected the Bank would cut the policy rate two more times this cycle, by 25 bps in April and July (ending at 2.50%). We now look for the quarter-point pace to continue each meeting until October, thus ending at 1.50%. The net risk is that we get to the endpoint sooner.
With the Fed forecast to continue its current pause until June and then resume a quarterly 25-bp rate cut clip, this means Canada-U.S. overnight rate spreads are going to push past -225 bps, testing the all-time extreme of -250 bps during the spring of 1997. With medium- and long-term Canada-U.S. bond yield spreads recently smashing through record negative levels, the market has been sensing extreme overnight spreads too. This will no doubt add to the Canadian dollar’s woes along with appreciation in the greenback as America’s tariffs go global. We see the loonie averaging around C$1.49 by this autumn and can’t rule out a run at the C$1.50 level, with the net risk this could occur quicker.
Economic Impact on the U.S.
Unfortunately, the tariffs announced on Canada, Mexico, and China proved as broad-based and comprehensive as we feared (approximately 43% of all U.S. goods imports). This will likely cause near-immediate supply chain disruptions in a number of industries (motor vehicles and parts the most obvious sector to watch), shortages of some products in stores, and a near-term price spike for many imported goods from America's three largest trading partners. We also expect an upswing in financial market volatility as market pricing resets to the newly evolving macroeconomic landscape, and increased policy uncertainty.
Incorporating the U.S. tariff increases and retaliation from Canada and Mexico announced so far, and assuming these higher tariffs remain in place a full year, we are marking down our baseline U.S. GDP growth forecast for full-year 2025 by 0.3 ppts to 2.1% and the 2026 call by 0.2 ppts to 1.8%, while lifting our core PCE inflation estimates by 0.3 ppts in each year to 2.8% and 2.4%. On a Q4/Q4 basis for 2025, we see growth at 1.7%, down from 2.2% previously, and core PCE inflation at a higher 3.0% instead of 2.4%.
Note, these forecast changes are preliminary and could move considerably in the weeks and months ahead due to financial market behaviour, as well as monetary and fiscal reactions, and if the new tariffs prove shorter-lived than assumed, or additional tariffs and retaliations are announced. Should the U.S. administration broaden the trade war to other nations, including much of Europe, as it has threatened, the economic harm will escalate, and we will need to revisit our forecast. On the other hand, a possible early withdrawal of tariffs would set the U.S. economy back on course for another solid year of growth.
Please see our previous research on the upcoming tariffs:
• The ‘America First Trade Policy’ Plan (Focus, January 31, 2025)
• Canada’s All-Important Tariff Policy Response (Focus, January 31)
• Will Canadian Energy Get Drilled? (Focus, January 24)
• Ten Tariff Truths (Focus, January 17)
• 25% Tariffs: What If? (Focus, December 6, 2024)
General Disclosures
BMO Capital Markets is a trade name used by BMO Financial Group for the wholesale banking businesses of Bank of Montreal, BMO Bank N.A. (member FDIC), Bank of Montreal Europe p.l.c, and Bank of Montreal (China) Co. Ltd, the institutional broker dealer business of BMO Capital Markets Corp. (Member FINRA and SIPC) and the agency broker dealer business of Clearpool Execution Services, LLC (Member FINRA and SIPC) in the U.S., and the institutional broker dealer businesses of BMO Nesbitt Burns Inc. (Member Canadian Investment Regulatory Organization and Member Canadian Investor Protection Fund) in Canada and Asia, Bank of Montreal Europe p.l.c. (authorised and regulated by the Central Bank of Ireland) in Europe and BMO Capital Markets Limited (authorised and regulated by the Financial Conduct Authority) in the UK and Australia. BMO does not represent that this document may be lawfully distributed, or that any financial products may be lawfully offered or dealt with, in compliance with any regulatory requirements in other jurisdictions, or pursuant to an exemption available thereunder. This document is directed only at entities or persons in jurisdictions or countries where access to and use of the information is not contrary to local laws or regulations. Their contents have not been reviewed by any regulatory authority. Bank of Montreal or its subsidiaries (“BMO Financial Group”) has lending arrangements with, or provide other remunerated services to, many issuers covered by BMO Capital Markets. The opinions, estimates and projections contained in this report are those of BMO Capital Markets as of the date of this report and are subject to change without notice. BMO Capital Markets endeavours to ensure that the contents have been compiled or derived from sources that we believe are reliable and contain information and opinions that are accurate and complete. However, BMO Capital Markets makes no representation or warranty, express or implied, in respect thereof, takes no responsibility for any errors and omissions contained herein and accepts no liability whatsoever for any loss arising from any use of, or reliance on, this report or its contents. Information may be available to BMO Capital Markets or its affiliates that is not reflected in this report. The information in this report is not intended to be used as the primary basis of investment decisions, and because of individual client objectives, should not be construed as advice designed to meet the particular investment needs of any investor. This document is not to be construed as an offer to sell, a solicitation for or an offer to buy, any products or services referenced herein (including, without limitation, any commodities, securities or other financial instruments), nor shall such Information be considered as investment advice or as a recommendation to enter into any transaction. Each investor should consider obtaining independent advice before making any financial decisions. This document is provided for general information only and does not take into account any investor’s particular needs, financial status or investment objectives. BMO Capital Markets or its affiliates will buy from or sell to customers the securities of issuers mentioned in this report on a principal basis. BMO Capital Markets or its affiliates, officers, directors or employees have a long or short position in many of the securities discussed herein, related securities or in options, futures or other derivative instruments based thereon. The reader should assume that BMO Capital Markets or its affiliates may have a conflict of interest and should not rely solely on this report in evaluating whether or not to buy or sell securities of issuers discussed herein. Dissemination of Economic Publications: Our publications are disseminated via email and may also be available via our web site https://economics.bmo.com. Please contact your BMO Financial Group Representative for more information. Additional Matters This report is directed only at entities or persons in jurisdictions or countries where access to and use of the information is not contrary to local laws or regulations. Its contents have not been reviewed by any regulatory authority. BMO Capital Markets does not represent that this report may be lawfully distributed or that any financial products may be lawfully offered or dealt with, in compliance with regulatory requirements in other jurisdictions, or pursuant to an exemption available thereunder. To Australian residents: BMO Capital Markets Limited and Bank of Montreal are exempt from the requirement to hold an Australian financial services licence under the Corporations Act in respect of financial services they provide to wholesale investors (as defined in the Corporations Act). BMO Capital Markets Limited is regulated by the UK Financial Conduct Authority under UK laws, and Bank of Montreal in Hong Kong is regulated by the Hong Kong Monetary Authority and the Securities and Futures Commission which differ from Australian laws. This document is only intended for wholesale clients (as defined in the Corporations Act 2001),Eligible Counterparties or Professional Clients (as defined in Annex II to MiFID II) and Professional Investors (as defined in the Securities and Futures Ordinance and the Securities and Futures (Professional Investor) Rules under the Securities and Futures Ordinance of Hong Kong). To Canadian Residents: BMO Nesbitt Burns Inc. furnishes this report to Canadian residents and accepts responsibility for the contents herein subject to the terms set out above. Any Canadian person wishing to effect transactions in any of the securities included in this report should do so through BMO Nesbitt Burns Inc. To E.U. Residents: In an E.U. Member State this document is issued and distributed by Bank of Montreal Europe plc which is authorised and regulated in Ireland and operates in the E.U. on a passported basis. This document is only intended for Eligible Counterparties or Professional Clients, as defined in Annex II to “Markets in Financial Instruments Directive” 2014/65/EU (“MiFID II”). To U.K. Residents: In the UK this document is published by BMO Capital Markets Limited which is authorised and regulated by the Financial Conduct Authority. The contents hereof are intended solely for the use of, and may only be issued or passed on to, (I) persons who have professional experience in matters relating to investments falling within Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (the "Order") or (II) high net worth entities falling within Article 49(2)(a) to (d) of the Order (all such persons together referred to as "relevant persons"). The contents hereof are not intended for the use of and may not be issued or passed on to retail clients. To Hong Kong Residents: In Hong Kong, this report is published and distributed by Bank of Montreal. Bank of Montreal (incorporated in Canada with limited liability) is an authorized institution under the Banking Ordinance and a registered institution with the Securities and Futures Commission (CE No. AAK809) to carry on Type 1 (dealing in securities) and Type 4 (advising in securities) regulated activities under the Securities and Futures Ordinance (Cap 571 of the Laws of Hong Kong). This report has not been reviewed or approved by any regulatory authority in Hong Kong. Accordingly this report must not be issued, circulated or distributed in Hong Kong other than (a) to professional investors as defined in the Securities and Futures Ordinance and the Securities and Futures (Professional Investor) Rules under the Securities and Futures Ordinance of Hong Kong, or (b) in circumstances which do not result in or constitute an offer to the public in Hong Kong. To Israeli residents: BMO Capital Markets is not licensed under the Israeli Law for the Regulation of Investment Advice, Investment Marketing and Portfolio Management of 1995 (the "Advice Law") nor does it carry insurance as required thereunder. This document is to be distributed solely to persons that are qualified clients (as defined under the Advice Law) and qualified investors under the Israeli Securities Law of 1968. This document represents the analysis of the analyst but there is no assurance that any assumption or estimation will materialize. To Korean Residents: This report has been provided to you without charge for your convenience only. All information contained in this report is factual information and does not reflect any opinion or judgement of BMO Capital Markets. The information contained in this report should not be construed as offer, marketing, solicitation or investment advice with respect to financial investment products in this report. To Japan Residents: This report has not been reviewed by any regulatory authority in Japan. This report is provided for information purposes only and it should not be construed as an offer to sell, a solicitation to buy, or a recommendation for any security, or as an offer to provide investment management or advisory or other services in Japan. Securities may not be offered or sold in Japan by means of this report or any other document other than to Qualified Financial Institutions within the meaning of item (i) of Article 17-3 of the Government Ordinance to enforce the Financial Instruments and Exchange Act (Kinyu Shohin Torihiki Ho Sekou Rei). Unless specified otherwise, the securities that may be offered to you are not and will not be registered in Japan pursuant to the Financial Instruments and Exchange Acts. To Taiwanese Residents: This report is not intended to constitute investment advice nor a public offer for any investment products to investors in Taiwan. This report should only be accessed by investors in Taiwan that are qualified to invest in investment products pursuant to relevant Taiwanese laws and regulations, and subject to sales restrictions as set forth in the relevant Taiwanese laws and regulations. BMO Capital Markets has not and will not secure the required licenses in Taiwan for the offer of securities and investment services. Any offer of securities has not been and will not be registered or filed with or approved by the Financial Commission of Taiwan and/or other regulatory authority pursuant to relevant securities laws and regulations of Taiwan, and may not be issued, offered or sold within Taiwan through a public offering or in circumstances which constitute an offer that requires a registration, filing or approval of the Financial Supervisory Commission of Taiwan and/or other regulatory authority in Taiwan under relevant securities laws and regulations of Taiwan. No person or entity in Taiwan has been authorized to offer or sell the securities in Taiwan. To PRC Residents: This material does not constitute an offer to sell or the solicitation of an offer to buy any financial products in the People’s Republic of China (excluding Hong Kong, Macau and Taiwan, the “PRC”). BMO and its affiliates do not represent that this material may be lawfully distributed, or that any financial products may be lawfully offered, in compliance with any applicable registration or other requirements in the PRC, or pursuant to an exemption available thereunder, or assume any responsibility for facilitating any such distribution or offering. This material may not be distributed or published in the PRC, except under circumstances that will result in compliance with any applicable laws and regulations. To Singapore Residents: This report is intended for general circulation and does not and is not intended to constitute the provision of financial advisory services, whether directly or indirectly, to persons in Singapore. You should seek advice from a financial adviser regarding the suitability of the investment products, taking into account your specific investment objectives, financial situation or particular needs before you make a commitment to purchase the investment product. This report has not been registered as a prospectus with the Monetary Authority of Singapore. Accordingly, it should not be circulated or distributed, nor may the securities described herein be offered or sold, or be made the subject of an invitation for subscription or purchase, whether directly or indirectly, to persons in Singapore other than (a) to an institutional investor or a relevant person as defined in and pursuant to and in accordance with the conditions of the relevant provisions of the Securities and Futures Act of Singapore or (b) otherwise pursuant to and in accordance with the conditions of, any other applicable provision of the SFA. To Thai Residents: The contents hereof are intended solely for the use of persons qualified as Institutional Investors according to Notification of the Securities and Exchange Commission No. GorKor. 11/2547 Re: Characteristics of Advice which are not deemed as Conducting Derivatives Advisory Services dated 23 January 2004 (as amended). BMO and its affiliates do not represent that the material may be lawfully distributed, or that any financial products may be lawfully offered, in compliance with any regulatory requirements in Thailand, or pursuant to an exemption available under any applicable laws and regulations. To U.S. Residents: BMO Capital Markets Corp. furnishes this report to U.S. residents and accepts responsibility for the contents herein, except to the extent that it refers to securities of Bank of Montreal. These documents are provided to you on the express understanding that they must be held in complete confidence and not republished, retransmitted, distributed, disclosed, or otherwise made available, in whole or in part, directly or indirectly, in hard or soft copy, through any means, to any person, except with the prior written consent of BMO Capital Markets.Furthermore, you shall not use (nor enable or procure any third party to use) these materials, in whole or in part, for the development of any software program, model, algorithm, or generative artificial intelligence (AI) tool or any other derivative content, including, but not limited to, training or using these materials in connection with the development or operation of a machine learning or artificial intelligence (AI) system (including any use of these documents for training, fine tuning, or grounding the machine learning or AI system or as part of retrieval-augmented generation). ADDITIONAL INFORMATION IS AVAILABLE UPON REQUEST BMO Financial Group (NYSE, TSX: BMO) is an integrated financial services provider offering a range of retail banking, wealth management, and investment and corporate banking products. BMO serves Canadian retail clients through BMO Bank of Montreal and BMO Nesbitt Burns. In the United States, personal and commercial banking clients are served by BMO Bank N.A., (Member FDIC). Investment and corporate banking services are provided in Canada and the US through BMO Capital Markets. ® Registered trademark of Bank of Montreal in the United States, Canada and elsewhere. ™ Trademark Bank of Montreal in the United States and Canada. © COPYRIGHT 2025 BMO CAPITAL MARKETS CORP. A member of BMO Financial Group
