Peter Schaffrik: Welcome back to European Markets. My name is Peter Schaffrik, and we're recording on the 12th of February, 2025. It seems like it's really all about tariffs, and even though initially it seems to be more about Mexico and Canada, it starts to become an issue for Europe too. At this point, I think it's quite instructive to see what we can learn from other regions. And in fact, we're quite fortunate, we've got Jason Daw with us today. Jason is our head of North America Rates Strategy, and he's just in London, and made time in his busy schedule to record this video with us. So, without further ado, Jason, why don't you fill us in? What's the latest in terms of tariff, and what's the story for Canada?
Jason Daw: Yeah, so as you know, Peter Canada was threatened with 25% tariffs across the board. Those were dialed back in pretty short order. Canada gave some concessions on border, and fentanyl. The new issue that's cropped up over the past couple of days is tariffs on steel and aluminum. This is being applied to all countries around the world, but Canada is particularly sensitive to that, given the US imports quite a large amount of those products from Canada. When you look at it from a macro perspective, it's pretty minor at this point. Steel aluminum exports represented around half a percent of GDP, around 3% of exports. So, it is manageable, and you would expect some retaliation from the Canadian perspective.
So, the interesting thing is when you look at the trade balance between Canada and the US and you strip out energy, we export a lot of energy to the US. That's the primary part of the surplus that Canada has with the US. But when you strip out energy, the US actually has a trade surplus with Canada. So, as the negotiations go on, as the threats, and counter measures evolve over time, Canada does have a lot of leverage in the situation with the US.
Peter Schaffrik: That's very interesting, Jason. That's a good starting point, and I want to return to that later, when I speak about Europe. But, before we go there, can you quickly fill us in? How does the Bank of Canada think about this? They must have surely done some analysis.
Jason Daw: Yes. In the recent monetary policy report on January 29th, they did have a whole section that looked at the scenarios, and how tariffs would affect growth and inflation. The numbers that they had for growth were very similar to the analysis they did back in 2018. It was quite similar to some of the work that we've done. It was quite similar to what some other think tanks have put forward. But essentially, if there was 25% across the board tariffs, and there was retaliation from Canada, the economic impact would be quite material, around 6% on GDP over a three to four year horizon. The first year hit would be around two, two and a half percentage points, and after the price level impact, the inflationary process would develop over time. So, the economic consequences would be pretty severe for Canada.
The question of how the Bank of Canada would have to react to that would really depend on a number of factors. How long tariffs are in place for, how large they are, and whether there would be fiscal policy offsetting that. And I think the rational expectation would be there would be fiscal policy, and the Bank of Canada probably wants to go at it pretty slow, as far as how they address the tariff issue. The last thing they want to do is provide too much stimulus from a monetary policy perspective, if there is fiscal policy that's also coming down the pipeline, and then tariffs are rolled back in a short period of time, and you run into a very similar situation that you had during COVID, and coming out of COVID, where you had a lot of stimulus, the lights were turned back on, and then all of a sudden you have an inflation problem. So, they will be pretty cautious, we think, on how they approach the monetary policy cycle against tariff uncertainty.
Peter Schaffrik: Thank you, Jason. That's very interesting, and I want to return to a few things that you said. So, if we look at Europe, the first thing I would say though, is if we look at the story about reciprocal tariffs, I don't necessarily think that this is going to be a market topic for us. The reason is, if you look at the charts on the screen at the moment, both for the Euro area on the left, and the UK on the right, the US already has higher tariffs than we impose, and therefore I think there is really very little at the US at the moment can do. I think what is much more important, if it comes to targeted tariffs.
Going to the steel and aluminum tariffs that have already been proposed, the two charts that you're seeing at the moment shows the EU's share in the US imports. And as you can see it is more meaningful, second-largest importer after Canada. However, when you put it in perspective, our exports to the US in steel, for instance, only make up about 5% of the European steel production. So, generally, I think that's not the biggest story, either. What would be, however, much more important, is targeted tariffs.
The third chart that you're seeing shows our exports to the US broken down by industries. And when you look at it, we're exporting a lot of pharmaceuticals, for instance, and we're importing a lot of energy, oil, and gas in particular. So that is where it could really hurt. But going back to what we learned from Jason, the question is also whether the US would target those specific areas, because those obviously would also raise prices in the US. Equally, the Europeans, as we're importing a lot of energy, if we tariff those, that would make it more expensive for us. So, our leeway for retaliation is also limited here.
Therefore, I think we'd really have to wait, what the US will do going forward, which probably requires the report that is due on the 1st of April. So, for the time being, markets have really shrugged off the story. We've seen that in Canada, we've seen that in Mexico to some degree, and we've certainly seen it over here in Europe, where we haven't really had a lot of detail. But I guess we will have to return to this topic time, and time again, as the year progresses. And I hope we're going to have Jason back at another episode, when the story evolves. So with that, thank you Jason, for joining us. Thank you everyone for watching, and I hope you're going to join us again next time.