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Investing.com - Growing speculation around potentially aggressive tariff actions taken by the US against Canada and Mexico adds to upside risks to inflation in America, according to analysts at Capital Economics.
President Donald Trump has threatened to slap 25% import tariffs on the two countries as soon as February 1, arguing that it is necessary to help stem the flow of illegal migrants and fentanyl into the US.
Although Trump has yet to formally institute the tariffs, a report in the Wall Street Journal over the weekend suggested that momentum is increasing among his advisors to roll out the levies.
To impose the duties quickly, Trump would need to employ emergency economic powers, the Capital Economics analysts said, adding that the decision would likely be subject to judicial review. But, due to the current conservative majority of justices on the Supreme Court, the analysts said they "would not bank" on Trump's tariffs being overturned.
Should they come into force, Canada has drawn up a list of potential retaliatory tariffs, albeit in a narrower scope than those rolled out by the US because a like-for-like response would "push up Canadian prices substantially", the analysts noted. Canadian leaders have proposed specific measures like a curtailing of oil and electricity exports to the US, but some provinces have expressed reservations about such a move.
Meanwhile, Mexico's government has not unveiled any proposals to respond to US tariffs, the analysts said. However, based on previous trade disputes, the country could focus on slapping surcharges on a limited number of goods produced in politically-important areas, such as agricultural products like pork and cork, the analysts said.
Crucially, when compared to a 10% universal tariff, which Trump has also said he is considering, the analysts said they doubt that exchange rate moves in the case of 25% levies would do as much to offset the impact on prices in the US.
"That means US buyers would need to pay higher prices, particularly on items that are harder to substitute, such as oil from Canada or motor vehicle parts that are ingrained in complex supply chains," they wrote.
Still, they estimated that a 25% tariff would boost US government revenue by $225 billion and represent a fiscal tightening of 0.8% of gross domestic product. Downside risks may face the US economy from "disruption in certain sectors", however, they argued.
The US tariffs would, at the same time, "hit Canada hard" and tip the country into recession, the analysts projected. Mexico would also be dented by a weaker peso, which could push domestic inflation back up above 5%, they estimated.