Monthly Economic Letter

Six months ago, the U.S. government announced a sweeping international tariff regime that sent shockwaves through financial markets and sparked predictions of imminent global recession.

While the Canada-U.S. trade relationship has yet to stabilize, 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 U.S. tariffs on Canadian products to 35% from 25% on all products not covered by the free trade agreement between Canada, the United States and Mexico.

Thanks to that trade agreement 85% of Canada’s trade with the U.S. is still exempt from tariffs. However, specific tariffs on certain sectors remain in place. These include 25% on autos and 50% on steel and aluminum (and products containing steel/aluminum). More recently, others have been added to the list, including 50% on copper and 45% 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 U.S. without customs duties. This suspension is hurting many Canadian small and medium-sized businesses that sell directly to U.S. 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% tariffs on autos, steel and aluminum remain.

Diversification of our exports—not so fast

Canadian exports fell by 2.8% in August, mainly due to tariff increases. Metal-related sectors, where tariffs were doubled to 50%, 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 U.S. (nearly 30% since January), this market still accounts for 75% 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% of Canadian aluminum was destined for the United States. The share going to the U.S. market remains very high, but has fallen by 24%, while exports to other European countries have risen rapidly. Exports to the Netherlands were up 74% on last year.

While export diversification remains limited, imports from countries other than the U.S. 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 U.S. 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 U.S. had lost more than 100,000 positions since January. The Bank of Canada estimates that nearly two million jobs in the country depend on U.S. 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 U.S. tariffs, inflation had returned to the Bank of Canada’s 2% 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-U.S. 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...

• U.S. 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 U.S., 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.

After three months of decline, the Canadian economy returned to modest growth in July (+0.2% real GDP), thanks to gains in service sectors, and more reassuringly, in goods-producing industries, according to Statistics Canada. 

While the mining, oil and gas sector contributed the most to the growth (+1.4%), the pleasant surprise of the month was an 0.7% gain in manufacturing, where companies have been grappling with significant challenges related to U.S. tariffs.

Statistics Canada’s preliminary estimates showed little growth in August, and the third quarter looks to have ended on a sluggish note. 

In the current context, this would still be a commendable performance. It would mean the economy avoided a second consecutive quarterly decline in real GDP (the definition of a technical recession).

However, as we enter the final quarter of the year, challenges continue to mount. GDP gains will be difficult to achieve in coming months, as uncertainty continues to weigh on business confidence and the U.S. adds new tariffs. 

Can households continue to support the economy?

Strong economic growth depends primarily on consumer spending, which accounts for 60% of GDP year in and year out. In the current economic climate, marked by high uncertainty, consumer demand plays an even more important role. Household confidence in the economy and strong demand for Canadian goods and services are key factors in stimulating business investment and hiring.

High interest rates in recent years prompted many households to cut back on debt. While debt has been rising slowly since the Bank of Canada began lowering rates, Canadian consumers remain in relatively good financial shape.

Relative to disposable income, household debt stood at 175% in the second quarter. In other words, for every $1 of available income, households owed $1.75, which remains among the lowest levels of the past decade. This bodes well for continued consumer spending, despite a weak job market. 

Additionally, disposable income rose by an average of 3.9% in the second quarter, compared to the previous year. Although down from last year's annual increase of 5.9%, this was still higher than inflation.

Lower borrowing costs meant that indebted households had more income available after debt repayment, and Canadians responded by spending that money.

Bottom line is that households will continue to support the economy, but consumption growth will be timid.

Further cut in key interest rate in September

The Bank of Canada has signalled it believes inflation is well under control in Canada and that the risks of a surge in prices remains contained, at least for the time being. This led the bank to lower its key interest rate in September.

The headline inflation as measured by the Consumer Price Index (CPI) reached 1.9% in August. However, inflation measures favoured by the bank, which are less volatile, remain stubbornly around 3%. 

The current economic slowdown, although well established, is not particularly alarming. This suggests the Bank of Canada will remain on the sidelines for now, leaving its key rate steady when it makes its October decision.

Phew! Employment is on the rise

In September, 60,400 jobs were created in Canada, after a cumulative loss of 106,000 jobs in the previous two months. A significant portion of the September job gains were generated by the private sector (+22,000 ), which suggests businesses are gradually regaining their footing. In other good news, employment picked up in sectors more vulnerable to tariffs where there have been significant losses since the start of trade tensions.  

The unemployment rate has risen rapidly this year due to economic uncertainty, slowing hiring and an increase in the number of potential workers. Despite the job gains in September, the unemployment rate remained at 7.1% as the number of potential workers grew once again.

In July, the number of job openings fell further to just under half a million, about 15% less than a year ago.

The impact on your business

• Consumers remain cautious and will continue to either slow their purchases of expensive items or turn to substitute products. However, rate cuts seem to be encouraging them to borrow more to keep up their spending. Look for ways to improve the value of your offerings to maintain adequate sales levels and ensure you have good inventory management.
• Interest rates are expected to continue to decline, but probably not in October. The Bank of Canada’s easing cycle is slowing, but recent rate cuts should support the economy and boost confidence, particularly among consumers.
• With the economic slowdown still very much ongoing, it’s not too late to adopt best financial practices at your company since it will take time before we see a resurgence of economic strength in Canada.

Alberta’s energy sector buffers trade headwinds

Alberta’s economy is expected to outperform the national average with decent growth this year. The energy sector has so far helped the province offset the impact of U.S. tariffs on its non-energy sectors. 

Population growth, while decelerating, is still giving a boost to the housing sector and consumer spending in the province. While uncertainty is still high, we expect healthy job gains to continue, supporting consumer confidence in the months ahead. We forecast provincial GDP to increase by 1.6% this year, exceeding Canada’s growth of 1.2%. 

Lower oil prices hurt but are offset by higher pipeline capacity 

OPEC has announced new supply increases, trade-related uncertainty persists and new tariffs keep getting announced. That’s a recipe for continued low oil prices in the months ahead. 

However, Alberta is being helped by lower breakeven costs and increased capacity, thanks to the TMX pipeline. Alberta’s oil industry is well-positioned to maintain current output levels helping the province diversify its oil exports on one hand and offset impact of lower oil prices on the other.  

Mining and construction keep growth positive in Saskatchewan

We are forecasting lower but still positive growth for Saskatchewan this year. While Chinese tariffs on canola seeds, on top of those already in place on canola oil, have increased pressure on the economy, other sectors have helped offset the impact. 

Job gains in sectors not hit by tariffs have outweighed losses in tariffed sectors, helping support consumer spending so far this year. 

Retail sales increased by 5% since January compared to last year’s levels. Additionally, housing starts were higher, reflecting strong construction momentum in the province. 

The mining sector has benefitted from higher prices and strong demand. Exports of metal ores and non-metallic minerals increased by 7.5% year-to-date. The $6.4-billion Jansen Stage 2 potash project continues to lift growth prospects this year and for following ones. 

We expect Saskatchewan’s growth to decelerate from its strong performance last year, coming in at 1.4% for the year, down from 3.4% in 2024. 

Tariff pain causes Manitoba to lag other provincial economies

Manitoba’s growth will remain under pressure in the months ahead, causing it to underperform the other prairie provinces this year.

Tariffs from trading partners have put pressure on Manitoba’s economy.
Indeed, three out of its top five export sectors are subject to tariffs from the U.S. or China. Exports fell 6% from the beginning of the year, and manufacturing sales were down by 1.5%. 

On the plus side, employment remained solid through the first seven months of the year, supported by positive consumer spending. The public sector helped, with job gains in the education and healthcare sectors as well as higher infrastructure spending.

The economy will benefit from stronger commodities prices, including for copper and gold, which exceeded US$4,000 an ounce for the first time. 

However, trade uncertainty and tariffs will weigh on provincial economy in the coming months. Our forecast is for Manitoba to grow by just 0.9% this year

The impact on your business

• •    Review your financial position and identify pain points and strategies to become more resilient. 
  •    The tariff picture has become somewhat clearer now. Start planning your growth projects and investments to benefit from lower borrowing costs.