By BDC
MONTREAL, Canada – Six months ago, the US government announced a sweeping international tariff regime that sent shockwaves through financial markets and sparked predictions of imminent global recession.
While the Canada-US trade relationship has yet to stabilise, the economic impacts have remained limited…for now. This month’s economic letter takes stock of how tariffs are affecting Canada. Is the worst behind us or still to come?
Where we stand
Tariffs may be making fewer headlines than they were six months ago, but their effects on the Canadian economy are real and continue to evolve rapidly.
Among the most recent developments was a general increase in US tariffs on Canadian products to 35% from 25 percent on all products not covered by the free trade agreement between Canada, the United States and Mexico.
Thanks to that trade agreement 85 percent of Canada’s trade with the US is still exempt from tariffs. However, specific tariffs on certain sectors remain in place. These include 25 percent on autos and 50 percent on steel and aluminum (and products containing steel/aluminum). More recently, others have been added to the list, including 50 percent on copper and 45 percent on lumber.
On July 30, the White House also suspended the de minimis duty-free exemption, which allowed packages valued at less than US$800 to enter the US without customs duties. This suspension is hurting many Canadian small and medium-sized businesses that sell directly to US customers.
Announcements to watch for:
- An additional 10% increase for lumber (bringing the Canadian tariff to 45%);
- 25% tariff on upholstered furniture, which will increase to 30% on January 1;
- 25% tariff on kitchen cabinets and vanities, which will increase to 50% on January 1;
- 25% tariffs on heavy trucks as of November 1;
- New threats of 100% on audiovisual productions and 100% on brand-name or patented drugs have been mentioned, but details are not available at this time.
For its part, Canada has lifted many of its retaliatory tariffs on the United States. Only 25 percent tariffs on autos, steel and aluminum remain.
Diversification of our exports—not so fast
Canadian exports fell by 2.8 percent in August, mainly due to tariff increases. Metal-related sectors, where tariffs were doubled to 50 percent, experienced sharp declines, as did lumber (-25.4%).
The slowdown was widespread, affecting 8 of the 11 major sectors. Despite slight increases in energy, aviation and consumer goods, losses in metals, lumber and agriculture dominated.
Export diversification has yet to show up in the data. Despite the sharp decline in exports to the US (nearly 30 percent since January), this market still accounts for 75 percent of total Canadian exports. Exports to other countries have also declined in recent months due to Chinese tariffs on our agricultural products and an ongoing global economic slowdown.
Some producers have managed to hold their own, at least in part. Such is the case with aluminum. Before the tariffs, over 94 percent of Canadian aluminum was destined for the United States. The share going to the US market remains very high, but has fallen by 24 percent, while exports to other European countries have risen rapidly. Exports to the Netherlands were up 74 percent on last year.
While export diversification remains limited, imports from countries other than the US continue to rise, suggesting that Canadian companies may be finding it easier to diversify their suppliers than their customers.
Employment suffers in the most affected sectors
Weak exports are slowing the Canadian economy as a whole. The extent and duration of the slowdown will depend on how businesses react to various tariff announcements.
Job losses have been observed in sectors heavily exposed to US trade since the beginning of the conflict, but employment remains stable elsewhere for now. In general, the labour market reacts slowly to economic changes, as hiring and training employees takes time and is costly.
Before unexpected job gains in September (+40,700), sectors with a high dependence on exports to the US had lost more than 100,000 positions since January. The Bank of Canada estimates that nearly two million jobs in the country depend on US exports.
No surge in inflation…for now
The impact of higher costs due to tariffs will depend heavily on demand and inflation expectations. A tariff is essentially a tax paid by importers. Even though the Canadian government cancelled most of its retaliatory tariffs in September, Canada is not immune to tariff-related inflation in the coming months.
Before this year’s rounds of US tariffs, inflation had returned to the Bank of Canada’s 2 percent target and price pressures were limited. But the arrival of the tariffs has complicated the situation by hampering exports and employment.
This slows demand and puts downward pressure on inflation in Canada. Other factors, such as the elimination of the carbon tax, have also helped keep inflation low in recent months.
However, the risk of seeing inflation flare again remains.
This is because the consumer price index reflects household consumption, so categories such as transportation, healthcare and furniture have a significant weight due to their direct impact on consumers.
Many of these goods are imported, making the CPI sensitive to global supply chain dynamics and exchange rate fluctuations in general. However, the tariffs imposed to date have been felt more by businesses than consumers.
Moreover, the Canadian dollar has remained weak since the tariffs were introduced, which supports exporters. But Canadian-US supply chains are closely linked, meaning higher tariffs could have a greater impact in the coming months if they remain at such high levels.
Still, as the economy slows under the weight of uncertainty, it’s more difficult for businesses to pass on cost increases than was the case during the last episode of inflation in 2022, which is another factor limiting price increases in the country.
In short…
- US tariffs have been boosted, affecting several key sectors (metals, lumber, furniture, etc.). The Canadian economy is in turbulent waters.
- Canadian exports are declining, particularly to the US, and diversification remains limited, despite efforts to the contrary. Export diversification, therefore, remains a strategic imperative for supporting growth and reducing the vulnerability of Canadian foreign trade.
- Employment in export sectors is under pressure, although the overall labour market remains stable and the sectors most vulnerable to trade rebounded in September.
- Inflation remains contained for now, but cost increases for businesses could be passed on to consumers if tariffs persist.
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