Investing.com — As the United States considers a comprehensive 25% tariff on imports from Canada and Mexico, the two countries face critical decisions on how to respond to this potential trade shock.
BofA Securities analysts warn that the tariffs, if implemented, could escalate into a real trade war, with significant economic consequences for all three countries.
The proposed tariffs, expected to take effect on January 20, would target all imports from Canada and Mexico. The US justifies this move as a way of solving its trade deficits, which are substantial with both neighbors.
However, the interconnectedness of these economies complicates matters. About 30% of Canada’s GDP and 40% of Mexico’s GDP is related to trade with the US, highlighting the heavy dependence of both countries on their southern neighbor.
BofA analysts point to a critical difference in the ability of the Bank of Canada and the Bank of Mexico to mitigate the economic consequences of a trade conflict.
Both institutions operate within the framework of inflation targeting, but face different constraints.
The Bank of Canada is in a position to take a dovish stance, potentially cutting interest rates to ease economic stress.
With Canada’s inflation rate currently on target at 2% and measures of core inflation similarly stable, the Bank of Canada has the flexibility to support the economy by easing monetary policy.
Such action would also weaken the Canadian dollar, helping to cushion the blow to Canadian exports.
On the other hand, Mexico’s central bank faces tighter restrictions. Headline inflation in Mexico is 4%, well above the Bank of Mexico’s 3% target, and core inflation remains stubbornly high.
Long-term inflation expectations are not anchored, further limiting the Bank of Mexico’s ability to cut rates. BofA analysts expect the Bank of Mexico to proceed cautiously, with a modest rate cut already factored into its 2025 forecast.
While both nations are likely to retaliate with targeted tariffs, the report suggests that avoiding escalation may be more beneficial in the long run.
Mexico, for example, has already shown a willingness to comply with US demands by imposing its own tariffs on Chinese goods to address concerns that it is a conduit for Chinese imports.
Similarly, both countries have stepped up efforts to address US concerns about drugs and illegal immigration, key terms of the proposed tariffs.
Although BofA Securities believes the imposition of tariffs is unlikely, given these mitigation measures, the risks cannot be ignored.
For Canada and Mexico, the choice is between measured retaliation and proactive diplomacy to avoid economic disruption.
For both nations, prioritizing economic stability while preserving long-term trade relations with the US will remain the biggest challenge.
