There is significant uncertainty surrounding the ongoing situation with tariffs, impacting the global economy, particularly along the Canada-US border. The situation remains fluid, with potential for change still very much in play.
Current projections indicate that tariffs could lead to a 1 percent contraction in Canadian GDP by 2025. Without tariffs, overall economic uncertainty is expected to limit growth to just 1.2 percent this year, falling short of the economy’s full potential. While predicting the depth of any economic downturn in 2025 is challenging, the current climate of trade instability is already showing detrimental effects.
Impact No. 1: U.S. Economic Slowdown
The latest forecasts signal a decline in U.S. GDP of approximately 2.4 percent in the first quarter. Although a projected increase in private investment (+4.8%) is on the horizon, it may not offset a slowdown in consumption, which is expected to remain flat (+0.4%).
The U.S. Federal Reserve must contend with persistent inflation and a tight labor market, maintaining the federal funds rate between 4.25 and 4.50 percent for its initial 2025 announcement.
The trade balance is particularly affected, as American companies have front-loaded orders from overseas suppliers, which limits overall GDP since imports are subtracted from the total. As a result, the traditional adage that “when the U.S. sneezes, Canada catches a cold” may not apply in this quarter. Canadian merchandise exports are predicted to rise, providing a boost to growth. Following a 6.0 percent increase in December, exports surged by 5.5 percent in January, reaching a record $74.5 billion. Exports contribute significantly to the Canadian economy, accounting for 19 percent of GDP, with 77 percent directed toward the United States.
Impact No. 2: Caution Among Canadian Businesses
In times of uncertainty, businesses often tend to pause or reduce investments, with some opting for cost-cutting measures like hiring freezes or decreased R&D spending. This cautious stance is anticipated among Canadian firms in 2025 amid a shaky business environment. Investment activity is expected to be modest at best.
In a survey conducted in January, many Canadian small and medium-sized businesses reported better financial positions entering 2025 compared to 2024. However, worries about the economic outlook have led many to halt expansion plans.
Consequently, only 45 percent of SMEs reported plans to invest in the upcoming year, down from 54 percent in October. This decline impacts major investment areas: non-residential buildings (down 5 points), machinery and equipment (down 8 points), and intangible assets (down 6 points).
Impact No. 3: Consumption Slows
As consumers grow concerned about an economic downturn and potential job losses, they tend to cut back on spending and increase savings. Recent surveys indicate Canadian consumers, worried about tariff implications, expect to limit their spending this year.
This drop in consumption will likely be felt most strongly in consumer discretionary industries, such as durable goods, clothing, and services including hospitality and leisure activities.
Future Projections
On a positive note, the Bank of Canada holds some capacity to support economic growth and mitigate potential slowdowns. With inflation under control for several months and a key interest rate of 2.75 percent still deemed restrictive, further easing of credit conditions and potential rate reductions can be anticipated throughout the year.
Additionally, a push for reduced trade barriers and a rise in Canadian consumer patriotism could help lessen the impact of tariffs. Data indicates that 90 percent of Canadians plan to react to U.S. tariffs, with 63 percent committing to buy more local products and many planning to decrease purchases from the U.S.
Furthermore, the ongoing depreciation of the Canadian dollar against the U.S. dollar, driven by tariff threats, reflects broader market uncertainty, with investors gravitating towards safer assets. In the first quarter of 2025, the Canadian dollar is likely to hover between US$0.68 and US$0.70, which could ultimately enhance the competitiveness of Canadian exports against U.S. imports.
Implications for Businesses
- Entrepreneurs will face challenges navigating an uncertain trade landscape that affects costs and the overall economic climate. Business owners should stay informed and be flexible, prepared to respond to evolving trade policies and economic conditions while avoiding hasty decisions.
- Uncertain economic conditions typically lead to tighter bank credit, so entrepreneurs should brace for potential difficulties in securing financing and may need to adjust their financial strategies accordingly. It’s also vital to create a robust human resources approach for various time frames.
- While all businesses will feel the effects of trade turbulence, the degree will vary depending on the industry’s exposure to tariffs. Companies should consider strategies to engage and retain customers across B2C and B2B landscapes, leveraging the current trend of Canadian consumer patriotism to promote locally sourced products and services.
