A major new report from BMO has laid out the economic stakes facing Canada as the country heads into contentious Canada-United-States-Mexico Agreement (CUSMA) trade negotiations next year.
The analysis, released this week, models three distinct scenarios for the future of North American trade—ranging from a relatively benign outcome that would still inflict economic damage, to a worst-case “continental divide” that would virtually guarantee a Canadian recession.
The timing of the report underscores the precariousness of Canada’s economic position. After nine months of tariff turbulence in 2025, with the U.S. imposing and rescinding various levies on Canadian goods, the mandatory CUSMA review process beginning in July 2026 looms as a deciding moment in the trade wars. The Trump administration has already signaled its intention to renegotiate rather than simply renew the agreement, while a pending U.S. Supreme Court decision on the legality of certain tariffs adds further uncertainty to an already volatile situation.
Here are three potential Canada-U.S. trade scenarios:
Scenario 1: Free trade ‘muddles through’—but the damage is already done
In BMO’s most optimistic scenario, continental free trade survives mostly intact. The U.S. maintains its current 7 percent average tariff rate on Canadian imports, reflecting existing sectoral levies on steel, aluminum, and lumber, while Canada modestly increases retaliatory measures to 2 percent.
For the United States, this scenario would have minimal impact, with companies still more than likely investing in the U.S. But Canada would feel substantially more pain. Business investment would remain suppressed as companies hesitate to expand capacity amid trade uncertainties. The labour market would weaken, though widespread job losses would be unlikely. Over time, Canadian economic activity would fall 1 percent to 2 percent below the path expected at the start of 2025, with consumer prices adjusting about 1 percent higher.
This “muddle through” outcome forms the basis of BMO’s current baseline forecast, which projects Canadian growth averaging just 1.3 percent in 2025 and 2026. That’s significantly weaker than the roughly 2 percent anticipated before tariffs escalated.
Scenario 2: ‘No special treatment’—Canada joins the tariff club
In BMO’s middle scenario, the Trump administration imposes across-the-board tariffs averaging 15 percent on Canadian imports, mirroring deals struck with countries like the U.K. and EU. Canada would then retaliate with 5 percent tariffs. On both sides of the 49th parallel, countries would apply levies only to foreign goods in integrated sectors like automotive to avoid compounding effects.
Here at home, this would inflict serious harm. Job losses in trade-related industries would weigh on consumer spending and wage growth. Business investment and exports would decline materially. A technical recession would be a strong possibility, though likely short-lived. Over time, economic activity could fall around 2.5 percent below pre-tariff trends, with consumer prices rising 1 percent to 2 percent.
In this scenario, the Bank of Canada would cut rates toward 2 percent, but remain hesitant to go lower due to inflation concerns. Tariff revenues would likely be dispatched to support affected industries. The effect on the U.S. economy would be limited, shedding around 0.4 percent from GDP while adding 0.4 percent to prices.
Scenario 3: A continental divide—CUSMA negotiations go off the rails
BMO’s worst-case scenario envisions a complete breakdown in bilateral relations, with the U.S. implementing a 35 percent tariff wall against Canadian imports. Canada then responds with 15 percent tariffs, enough to avoid capitulation, but calibrated to prevent escalation.
For Canada, this would be devastating. A recession would be virtually assured. In the first year, real GDP would decline 1 percent to 2 percent, with unemployment jumping 1 to 1.5 percentage points as job losses would cascade across the economy. The Bank of Canada would cut rates to around 1 percent. The Canadian dollar could lose 10 percent of its value, with consumer prices ultimately rising 4 percent. Over time, economic activity would fall 5 percent below pre-tariff trends—representing deep structural damage. Firms would favour the U.S. for new investment, and Canadian productivity would remain under severe pressure.
Trump’s America would experience meaningful but manageable harm, with economic activity eventually declining around 1 percent relative to pre-tariff trends and prices rising 1 percent. Northern states would slow noticeably, but even in the most trade-exposed states, exports to Canada generally account for less than 5 percent of GDP. Financial markets would react swiftly, and Canadian equities would decline sharply while U.S. markets would struggle given elevated valuations. This profound asymmetry in economic pain would give U.S. negotiators overwhelming leverage in any future negotiations.
What makes BMO’s analysis particularly sobering is the asymmetry it reveals. Even in the most optimistic scenario modeled by the bank’s economists, Canada would suffer serious economic harm while the U.S. would experience minimal impact.
Generative AI assisted in the production of this story.
Editor’s note: A previous version of this story listed the incorrect line of latitude separating Canada and the U.S.
