This newsletter was distilled from an RBC Thought Leadership piece written by RBC Chief Economist, Frances Donald and Assistant Chief Economist, Nathan Janzen.

The Impact of U.S. Tariffs on the Canadian Economy

With Donald Trump back in office, concerns about the potential consequences of U.S. tariffs on the Canadian economy are once again in the spotlight. While this isn’t Canada’s first experience dealing with trade barriers—lessons were learned from the softwood lumber tariffs in 2017 and the steel and aluminum tariffs in 2018—the potential scale and scope of new tariffs could far exceed those past instances, making previous experiences less useful as predictors of what lies ahead.

As Canada braces for the possible economic fallout, there is a temptation to distill the impact into a single number representing the hit to growth or employment. However, the reality of tariffs is far more complex. Even a fraction of the proposed tariffs could have immediate, significant, and long-lasting effects on Canada’s economy, while also harming the U.S. economy. The extent of the impact will depend on a range of unpredictable factors, including the size and scope of the tariffs, currency fluctuations, central bank responses, and government policy actions, such as retaliatory measures or industry support.

To navigate this uncertain landscape, businesses, policymakers, and consumers will need more than just a headline figure—they will require a framework to understand how tariffs ripple through the economy over time. Below is an outline of the key ways tariffs could affect Canada and some assumptions that can be made about the broader economic consequences.

How U.S. Tariffs Could Impact Canada’s Economy

Before Tariffs Take Effect

1. Business Uncertainty Slows Investment

   • The mere threat of tariffs could cause Canadian businesses to delay investments and expansion plans due to uncertainty about future trade conditions.

2. Temporary Boost in Trade Activity

   • If tariffs are announced but not immediately implemented, American importers may rush to stockpile affected Canadian goods before prices rise. This could temporarily boost trade and economic activity on both sides of the border, but at the expense of future demand.

After Tariffs Are Imposed

3. Higher Prices and Lower Demand for Canadian Exports

   • Tariffs make Canadian goods more expensive for U.S. buyers, likely reducing demand. However, the extent of the decline depends on several factors:
     a. If the Canadian dollar weakens, it could offset some of the cost increase, making Canadian goods more competitive.
     b. If lower-cost substitutes are available, demand for Canadian products may drop more sharply.
     c. Some businesses or consumers may absorb the higher costs rather than cutting back on purchases.

4. Canadian Retaliation and Its Economic Effects

   • Canada may impose retaliatory tariffs on U.S. goods, leading to further economic disruptions. These measures could slow economic growth and increase inflation, affecting consumers and businesses alike.

5. Broader Economic Ripple Effects

   • Reduced activity in key export industries could impact related sectors. For example, if an auto plant cuts production due to tariffs, job losses could spread to local businesses such as restaurants, retail stores, and entertainment venues.

6. The Bank of Canada’s Response

   • Tariffs create a dilemma for the central bank. They can push prices higher (inflationary effect) but also weaken economic growth (deflationary effect). While central banks typically avoid reacting to one-time price increases from tariffs, the broader economic slowdown could prompt interest rate cuts, influencing sectors like housing and investment.

7. Government Fiscal Support

   • Federal and provincial governments may introduce policies to support industries and workers affected by tariffs. While short-term stimulus measures could help soften the immediate impact, a prolonged economic slowdown could strain Canada’s fiscal position. Unlike the global financial crisis or the COVID-19 pandemic, this would be a Canada-specific shock, potentially putting its AAA credit rating under scrutiny.

What We Can Expect from Tariff Shocks

Despite uncertainties, several key assumptions can be made about how tariffs would affect the economy.

1. Trade-Sensitive Industries Face the Greatest Risk

• Since tariffs directly target trade flows rather than production, industries most dependent on cross-border trade—such as automotive manufacturing—are particularly vulnerable.

• The highly integrated nature of North American supply chains means that tariffs could be applied multiple times during production, compounding the costs.

2. Tariffs Hurt Even Without Direct Retaliation

• U.S. importers bear the initial cost of tariffs, but since Canadian and U.S. industries are deeply interconnected, higher import costs will also increase production costs for American exporters, ultimately feeding back into Canada’s economy.

3. Alternative Markets and Substitutes Matter

• Some industries, particularly those in natural resources, may find it easier to redirect exports to other global markets. For example, agricultural commodities often have globally set prices and can be rerouted more quickly than manufactured goods.

• In contrast, manufacturing sectors may struggle to shift supply chains in the short term, making them more exposed to tariff impacts.

4. The Scale of Tariff Increases Is Critical

• The tariff hikes during Trump’s first administration were relatively modest, raising the average U.S. tariff rate by about 1.5 percentage points. This limited inflationary effects and allowed some businesses to absorb the costs

• A more aggressive tariff regime would likely have greater economic consequences, amplifying disruptions to trade and investment.

5. Tariffs May Not Achieve Their Intended Goals

• One major aim of tariffs is to reduce the U.S. trade deficit, but this is unlikely to happen unless broader economic factors, such as government borrowing, change.

• The U.S. trade deficit has remained large because of high levels of borrowing from abroad. Unless U.S. consumers significantly cut back on imports and increase savings—something that usually only happens during recessions—tariffs alone won’t balance trade.

• Another goal of tariffs is to reshore production to the U.S., but with a tight labor market and potential restrictions on immigration, finding enough workers to ramp up domestic manufacturing could be a significant challenge.

While Canada has navigated past tariff challenges, the potential for broader and more aggressive trade barriers under a second Trump administration presents a significant economic risk. The effects of tariffs are complex, extending beyond immediate price increases to impact business investment, employment, monetary policy, and government finances.

A clear understanding of how tariffs filter through the economy—both in the short and long term—will be essential for businesses, policymakers, and individuals preparing for the road ahead.

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