In this week’s The Seven…

• Still waiting - on potential tariff action
• Meh, but better - business sentiment in Canada
• Inching forward - consumer spending
• Gift wrapped - inflation (mostly) cooperates ahead of BoC decision
• In our control - internal trade barriers
• Next week:  Western Canada Economic Forum
• Interesting Fact: The importance of interprovincial trade 
• Chart of the Week: U.S. trade balance in oil

‘The Final Countdown’, a 1980s rock classic from the band ‘Europe’, has been running through my head. Last week, it was the countdown to President Trump’s inauguration, and now we wait on potential tariff action. 

With geopolitical headwinds and inflation at target, we see the Bank of Canada keeping its rate cutting streak alive next week - this time with a smaller 25 basis point move.

In our Chart of the Week, we dig into the U.S. trade balance in oil following President Trump’s recent comments about Canada at Davos:  "We don't need their oil and gas. We have more than anybody."

Off and on  - Trump threatens tariffs on Feb 1

A brief sigh of relief. The day of Trump’s inauguration, no tariffs were signed by Executive Order. Then later that day President Trump again talked about hitting Canada and Mexico with 25% tariffs on February 1, citing border security concerns (specifically fentanyl). That threat was reiterated in Trump’s Davos appearance yesterday. For what it’s worth, Polymarket, a prediction market, puts the odds of 25% tariffs on Mexico/Canada before March at 25% (as of this morning).

What does this mean? It seems some type of tariff is coming. What’s far less clear is the coverage, duration and timing.   

The potential inflationary impact should give reason for pause. The Federal Reserve still has an inflation fight on its hands, with the latest headline reading a still-elevated 2.9% and the Fed now more reluctant to cut than before. The Peterson Institute estimates a 10% across the board tariff would raise inflation in the U.S. this year by 0.6 percentage points, or 1.3 points with full retaliation.

Inflation gift wrapped

Back in Canada, the final inflation reading of 2024 wasn’t exciting. It was more of the same ‘around the 2% target’ we’ve become used to, and bang on consensus expectations.   

But the GST holiday flattered the 1.8% December print, and core inflation readings are proving more stubborn. The Bank has said it will ‘see through’ tax holiday inflation gyrations, which will also be the case when the tax reinstatement adds to inflation in February/March.

Getting to the point, the December inflation is good enough in our view for the Bank of Canada to cut by 25 points next week. Toss in mounting tariff risks and we feel the Bank should cut its way back to neutral sooner than later (we see the landing spot at 2.5% in our base case).

For Monetary Policy Report enthusiasts (who isn’t?), any bets on how the BofC will handle looming tariff threats? We anticipate to see a forecast reflecting only what’s announced, but a special feature on what happens if Trump’s 25% blanket tariffs are levied (similar to their piece in July 2019).

Businesses still cautious as battle switches 

With the BofC winning the inflation battle, the nation has collectively turned its heads to tariff threats. That shift seems to be bearing out in recent survey data released this week by the Bank of Canada.  

Interestingly, given the geopolitical environment, businesses are cautiously more optimistic. The sales and investment outlook has improved and the Bank’s overall outlook indicator picked up in the final quarter of 2024. According to the Bank, the credit mainly goes to lower interest rates, and the expectation of more rate cuts to come. Businesses and consumers expect cost and inflation pressures to cool further. 

Notably, for Alberta, the survey found more optimism in the oil and gas sector, where market access (Trans Mountain Expansion and Coastal Gas Link to LNG Canada) is bolstering investment and production prospects. 

What about tariffs? 40% expect that the new U.S. administration will have a negative impact on their business, but one-third said it’s too early to tell. 

In our view, the survey points to a more ‘wait and see’ type attitude vs. a wholesale change in business plans. Further, our sense is that this survey captures that some type of tariff is inevitable, but not the full sweeping tariffs that Trump has threatened.

Consumers not celebrating yet, but slowly opening up their wallets

There are also signs that rate cuts and easing inflation are lifting the spirits of consumers. Retail sales are trending higher, and consumers are somewhat more optimistic (though sentiment remains subdued). But it’s been a grind, with retail sales down last year when netting out the impacts of inflation and population growth. We see Alberta consumer spending rebounding modestly this year as the benefits of interest rate cuts kick in with a lag. 

Within our borders - free internal trade 

To many, the latest tariff threat has been a wake up call for Canada. It’s worth noting that long before Trump 2.0, there were challenges at home. Real business investment remains below 2014 levels, and labour productivity has been languishing. 

So what is in our control? Lots of things. For example, streamlining and fast tracking major project approvals, building transportation infrastructure to new markets (e.g. rail, ports, pipelines, LNG, etc.), encouraging scaling of start-up companies, and knocking down internal trade barriers. What’s on your list?

One domestic roadblock that’s hard to dispute is the need to remove internal trade barriers. As protectionist sentiment takes root globally, Canadian provinces should do what they can to trade freely together.

The benefits of removing internal trade barriers are massive. IMF research shows a boost of about 4% to  real GDP per capita, while more recent work by the McDonald-Laurier Institute suggests a long-run GDP boost of 4.4-7.9% if internal trade barriers were removed through mutual recognition policies.

Western connection

A nice segue to my next topic: Internal trade between the Western provinces, as I travel to Regina to speak at next week’s Western Canada Economic Forum.

The Western provinces of B.C., Alberta, Saskatchewan and Manitoba have had a free trade agreement since 2010 called the New West Partnership Trade Agreement (NWPTA). It is considered a more liberal trade arrangement than the one covering all provinces and territories - the Canada Free Trade Agreement (CFTA).  

University of Calgary economist Trevor Tombe estimates that Ontario, by joining NWPTA, could boost its GDP by $4.1 billion a year. 

Trade between the provinces is significant (see chart). For example, Alberta exported more than $26 billion annually between the years 2016 to 2021 (latest data available) to its western counterparts, with oil and gas and agricultural products topping the list of exports.

Interesting Fact…Internal trade between provinces is not as large as our trade with other countries, but it’s a big deal. Interprovincial trade of goods and services* was $532 billion in 2023, compared to $978 billion in Canada’s international exports. At one point, in the early 1980s and prior to major international trade agreements, the two were roughly on par (see chart).

*represents the value of interprovincial exports (which, by definition, also equals interprovincial imports).

Charts of the Week:  U.S. trade balance in oil and petroleum products

Last week we showed that Canada accounts for only 5% of the U.S. trade deficit.

But even that overstates Canada’s contribution. Excluding oil and gas, the U.S. runs a trade surplus with Canada, which we estimate to be in excess of $US 50 billion in 2023.  

That leaves a trade deficit in energy with Canada. However, an energy trade deficit with Canada enables the U.S. to run energy trade surplus with other countries. 

The U.S. has a secure and reliable supply of discounted crude oil from Canada. This allows the U.S. to export its rising supply of higher priced light barrels and refined products to overseas markets, as shown in our Chart of the Week.  

The U.S. now comfortably exports more than it imports in crude oil and petroleum, running a surplus with most countries (see second Chart of the Week).

As we argued last week, a U.S. tariff on Canadian oil and gas would be self-defeating. It would raise prices at the pumps for U.S. consumers, not help with the U.S. trade deficit, and undermine North American energy security.