indicatorThe Twenty-Four

The Seven, January 31, 2025

Tariff reality bites | By Mark Parsons, ATB Economics

31 January 2025 7 min read

In this week’s The Seven…

  • Buckle up - tariffs closer to reality
  • Downward bias - BofC could cut deeper
  • Different strokes - U.S. Fed stays on the sidelines
  • On the move…inside the province
  • Interesting Fact: Punching above its demographic weight - Western Canada’s economy
  • Chart of the Week: The dark cloud of uncertainty

We are still in the early innings of 2025, and our December outlook theme “shifting sands’ is holding up so far. We head into the weekend with reports from the White House now indicating that 25% tariffs on Canada and Mexico will be ‘put in place’ February 1, though it's unclear if there will be any exemptions and when the tariffs will actually take effect. 

Our chart of the week measures the spike in economic policy uncertainty in Canada, a key factor holding back in investment.  

Message from Macklem - Buckle up

The message from Bank of Canada governor Tiff Macklem and company this week following its rate cut decision was reassuring and worrisome at the same time. On the one hand, inflation is cooperating, and the economy is getting a boost from interest rate cuts. On the other hand, buckle up. A trade war could be coming, and according to the Bank’s own scenario this could push the economy into a recession. 

Under that dark cloud of looming tariffs, the Bank of Canada put out a forecast. Not an ideal time, but they had to - it was on the calendar.  

Their forecast assumed no tariffs, except for the effects of uncertainty (see our chart of the week). GDP growth was nudged down to 1.8% for this year and next year, thanks to slower population growth. This is closely aligned with our call.  

The interesting piece came from the tariff scenario. The Bank modelled a 25% broad-based tariff, and Canadian countertariff. It showed a 2.5% reduction in real GDP growth in year 1 and 1.5% in year 2, relative to the base case. As such, the cumulative decline in the level relative to the base case is approximately 4% by year 2. 

Sidenote: these impacts can be confusing. This is not the outright decline in GDP, but rather the decline from the ‘base case’ without tariffs. So using the Bank’s base case forecast and assuming year 1 is 2025, we figure that would put the actual decline in real GDP in the neighbourhood of -0.7% this year, and growth of only about 0.3% next year under this tariff scenario.  

These impacts are very close to our Canadian assumptions from our December forecast (see chart). 

These shocks are based on broad-based tariffs (i.e. no exemptions) remaining in place. It’s not hard to imagine a scenario where tariffs are imposed for a few weeks or months, then removed. Or a scenario where certain goods are exempt (President Trump did mention yesterday potentially excluding oil, which would soften the impacts particularly in Alberta). Treat this a bookend, worst case tariff scenario.

Further, we will likely see front-loading of inventories as companies rush to avoid tariffs (the implementation date will be later than the announcement). That is, there could be a temporary jolt in the near term, with a big drag later.

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What does this mean for interest rates going forward? To unpack this, I had a discussion with our Managing Director of Rates, Mark Johnson at ATB Capital markets. A glimpse of this conversation is here. We agreed that under a tariff war scenario the Bank will put more emphasis on downside risks to growth. In other words, it will see through the transitory impacts of tariffs on inflation, and speed up its rate cuts. We could see a 2% BofC by mid-year, and fall below that mark later in the year under a tariff war. That means that the BofC could temporarily push below its own neutral range of 2.25-3.25%.  

On the move…within the province

This week we talked about the persistence of Calgary’s population growth - a 6% increase on top of already meaty 5.8% in 2023. That’s a gain of over 190,000 people in just 2 years, just in Calgary’s CMA!

The influx has put pressure on home prices in Calgary, which have jumped since COVID, far outpacing the provincial average.

As we’ve noted, affordable housing is luring folks from the rest of Canada, even to more expensive Calgary. While Calgary housing has become more costly, it’s still cheaper than many other markets where folks are coming from (inflows have been primarily from Ontario and BC).

But now that Calgary’s home prices have shot up, shouldn’t people be looking for more affordable housing inside Alberta? We think this is happening.   

One clue is the dramatic improvement in Edmonton’s housing market over the last year, with benchmark prices and home sales picking up steam since the summer of 2023.  

Another clue is the sharp acceleration in Edmonton’s population, at 4.7% in 2024 vs 3.9% in 2023. Further, growth outside the two major CMAs picked up from 1.6% to 2.2%.   

Finally, and perhaps most convincingly, Calgary recorded net outflows to other parts of the province last year. The number isn’t big (only 729), but it is the first net outflow since 2008. Further, Edmonton saw a net intraprovincial increase of 2,924, while census agglomerates saw a smaller outflow than normal.

Bottom line: The chasing affordability theme is not nearly as evident in-province, as it is between-provinces. But we see some signs that it is occurring. Further we think ‘chasing affordability’ will remain a driving force in 2025, as people continue to seek out less expensive options.

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Different strokes - The Fed holds, BofC cuts

A few hours after the BoC cut, the Federal Reserve decided to stay on the sidelines. Why the divergence? The short answer is the U.S. Fed chair Jerome Powell is dealing with a much stronger economy than Bank of Canada’s Governor Tiff Macklem, along with much more stubborn inflation.  

Powell said “we don’t need to be in a hurry”. In addition to sticky inflation, there is also a desire to assess the potential impact of Trump’s fiscal and trade policies, which are widely viewed to put upward pressure on prices. It all adds up to a wait-and-see approach at a much higher rate (4.25-4.5%) than where the Bank of Canada stands.

Our sense is that the BofC is keeping one eye on its rate divergence, and the dampening impact it's having on the loonie. But it’s also comfortable to move alone, knowing that we are in a much different situation.

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Interesting Fact…Western Canada packs some economic punch

Speaking at the Western Canada Economic Forum in Regina this week, there were a few feelings I sensed from the audience: 1) Fear of a looming tariff war 2) Urgency to get projects built, diversify export markets, sell our resources to the world and remove internal trade barriers and 3) long-term optimism for the future. 

On point 3),the west is enriched with abundant resources the world needs: energy, critical minerals, food and forest products. It’s also worth noting that the Western provinces already have a strong partnership through the New West Partnership Trade Agreement (NWPTA) as attention turns to knocking down internal trade barriers. But much more could be done (see this piece by the McDonald Laurier Institute on mutual recognition). 

While the west is heavily dependent on the U.S. market, there has been headway on export diversification. For example, in the energy sector, crude oil on the new Trans Mountain Expansion project is reaching Asia, propane is accessing Japan and South Korea, and coming soon LNG will move off the west coast.  

Finally, the starting point is strong. As shown in the following chart, the west punches above its demographic weight. It has a much higher share of Canadian business investment (45%), nominal GDP (36%) and exports (37%) than its share of the national population (32%) as of 2023.

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Chart of the Week: The dark cloud of uncertainty

We know that tariffs hurt the economy through the trade channel by reducing the demand for Canadian goods. 

What’s missing (and harder to model) is the impact of uncertainty. The ‘on and off’ again nature of Trump threats puts a chill on investment. Also thrown into the mix is domestic policy uncertainty. In Canada, federal policy is in flux, with a prorogued parliament, a  liberal leadership race and a pending election. 

In short, not a lot of clarity on what policy looks like on both sides of the borders.

Uncertainty sounds like a nebulous concept, and nearly impossible to measure. That didn’t stop economists Scott Baker, Nicholas Bloom, and Stephen Davis from trying. They created an index based on media references. While not perfect, their index is correlated with other proxies like stock market volatility. It also foreshadows investment and employment declines.  

In Canada, that index spiked to its highest level since COVID. So yes, uncertainty is holding back already sluggish levels of business investment, something the Bank of Canada noted this week.

Answer to the previous trivia question: The United States launched its first satellite, Explorer 1, into orbit on this day in 1958.

Today’s trivia question: When was February added to the Roman calendar?

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