Courtesy of President Trump chickening out on breaking the USMCA/CUSMA free trade agreement on autos, the damage due to the tariff nuttiness from south of the border has been somewhat limited in Canada. The figure above shows the unemployment rate, which has finally rolled over.
There has been a malaise in the Canadian economy after the unemployment rate marched upward from the modern historical low created in the post-COVID stimulus period. In the absence of any other structural changes to the economy that would allow a lower unemployment rate, it was unlikely that the post-COVID employment metrics would stick. Nevertheless, the Canadian economy is still muddling along, so the upward trend in the unemployment rate had to break.
There is a long argument by post-Keynesian economists that the NAIRU concept is silly, and that unemployment rates reflect policy choices — it would be possible to change policies to reduce them without causing ever-accelerating inflation. Although I agree with that assessment, the qualifier that there be structural policy changes cannot be ignored. The current economic structure limits how far the stimulus can quickly lower the unemployment rate without inflationary consequences. It is certainly possible for the unemployment rate to drop below NAIRU estimates during a long expansion without an inflationary accident, as seen in the 1990s. However, the economy was hit by some large “shocks” in the COVID period and its aftermath, and we obviously hit the inflationary limit as a result of those shocks.
The chart above shows the inflation rate (headline and core, where core is excluding food and energy). Energy prices have been soft lately, but Canada has been hit by some food price shocks. The most painful inflation for the author has been the explosion in coffee prices, which have been hit by poor growing conditions and tariffs faced by roasted beans sourced in the United States (both American and Canadian). However, inflation has otherwise reverted to levels that are typical for expansions in the modern era. This is not great inflation performance given the softness in the economy, but it leaves the Bank of Canada wiggle room to react to growth concerns.
However, the outlook for 2026 is murky. The USMCA/CUSMA free trade deal is up for re-negotiation, and the Trump White House is signalling a desire to once again go after Canada’s dairy supply management system. They are also hinting at a lack of satisfaction with provincial governments cutting American booze out of their markets. Giving any further ground on dairy would be political suicide for Marc Carney (there is already a scheme that allows a quota into Canada), and the Americans have a pretty sad understanding of Canadian constitutional sclerosis if they think a bunch of provincial governments are going to help the extremely unpopular Trump out. As such, the demands are going to hit extremely tough resistance.
The negotiations are likely to once again be an ugly affair, with threats of annexation, support for Albertan/Québécois separatists, etc. However, the path of least resistance is to do nothing, such as doing something like extending the current arrangements for one year so Trump can try to get another kick at the can in 2027. Blowing the entire treaty up would be disastrous for what is left of the American automakers’ operations in Canada. Given the failure of the American automakers to keep up with the competition in electric automobiles, the long-term viability of the operations is already questionable, but postponing hard decisions is going to be preferable for everyone involved.
Of course, there is a risk that the American economy rolls over due to the decision of the Republicans to kick American consumers in the teeth and at the same time disrupt activity with wacky tariff policies. A rapid downturn in the American economy would certainly drag along the Canadian economy. However, a sectoral slowdown courtesy of a retrenchment in data centre spending would have less direct linkages to the Canadian economy.
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