Canadian government officials said there's an increasing likelihood US President Donald Trump will give six-months' notice to withdraw from Nafta, dragging down the loonie, yields on government bonds and Mexico's peso.

[OTTAWA] Canadian government officials said there's an increasing likelihood US President Donald Trump will give six-months' notice to withdraw from Nafta, dragging down the loonie, yields on government bonds and Mexico's peso.

The officials, speaking Wednesday on condition they not be identified, declined to say whether they think the likelihood of Mr Trump following through on repeated threats to quit the pact now exceed 50 per cent. A White House official, speaking on background, said there hasn't been any change in the president's position on the North American Free Trade Agreement.

The comments have raised worries the Nafta countries - the US, Canada and Mexico, who trade more than US$1 trillion annually - are further apart on coming to an agreement than feared. The Canadian officials said a US withdrawal notice could come at any time, and Prime Minister Justin Trudeau's government is considering all options related to industries that would be most affected.

Mr Trump withdrawing from Nafta "was always a risk, but that risk is clearly more elevated now," said Brian DePratto, senior economist at Toronto-Dominion Bank.

Trade relations between the two countries have taken a dramatic turn this week, with Canada escalating its spat with the US by filing a World Trade Organization complaint over American duties against Canada and other countries. US Trade Representative Robert Lighthizer called that a "broad and ill-advised attack."

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Officials from the three nations are maneuvering to frame the debate ahead of the sixth round of Nafta talks in Montreal starting Jan 23, when negotiators are expected to tackle contentious issues they bypassed at discussions last month in Washington. Canada has been pushing Nafta's US defenders to speak up to save the pact - the officials' comments Wednesday may add domestic pressure on Mr Trump to not issue the withdrawal notice.

The three countries have already planned a subsequent round of talks in February in Mexico City, two people familiar with plans said.

Implied odds that Bank of Canada Governor Stephen Poloz will raise interest rates next week dropped to as low as 57 per cent immediately after news that Mr Trump may withdraw, from 84 per cent just before, according to data compiled by Bloomberg. The odds later rebounded to about 80 per cent after the White House official comments.

Shares of companies considered most at risk declined. Kansas City Southern fell as much as 4.6 per cent after the report, its biggest loss in more than eight months. Canadian Pacific Railway Ltd sank 3.3 per cent in Toronto and CSX Corp slipped 1.7 per cent. General Motors Co slid as much as 3.3 per cent while auto-parts stocks also fell, paced by Lear Corp Canada's S&P/TSX Composite Index extended declines after the news, dropping as much as 0.6 per cent. The index closed down 0.4 per cent in Wednesday trading.

The Canadian dollar fell 0.7 per cent to C$1.2574 against the greenback at 4pm in Toronto. The peso fell as much as 0.9 per cent to 19.3963 per US dollar, before rebounding later in the day. The rate on Canada's two-year government bonds declined 6 basis points to 1.74 per cent. The yield on 10-year debt was down four basis points to 2.16 per cent.

"The market's been too complacent regarding Nafta termination risk for too long," said Bipan Rai, a Toronto-based foreign-exchange and macro strategist at Canadian Imperial Bank of Commerce. "Outside of the Bank of Canada meeting next week, there should be upward pressure on USD/CAD as that premium increases into the next round."

Talks to overhaul Nafta began in August. They have so far yielded little firm indication of whether a deal can be reached to update the pact, the Canadian officials said.

Canada, along with Mexico, has so far rejected some of the Trump administration's hardline demands and refused to offer counter-proposals - and warned there won't be a deal unless the US puts water in its wine. The US is insisting on a five-year automatic termination clause, stricter rules on autos, government procurement and dairy, and the overhaul or elimination of dispute panels.

Mexican Economy Minister Ildefonso Guajardo has said his country won't negotiate under duress and will leave the table if the US initiates the withdrawal process. The Canadian officials said Wednesday they weren't sure how Mexico would react to any withdrawal notice but that Canada would keep negotiating after one was given. A withdrawal notice doesn't mean Nafta would be killed - a country can give notice and then not actually leave.

"What's surprising to me is that everybody is so surprised. We knew the last round of talks ended with a very cold shoulder being given by the Americans to Canada and Mexico's positions, and we heard from Mr Trump saying we'll probably have to pull out," CIBC Chief Economist Avery Shenfeld said.

Mr Shenfeld sees the loonie falling to 75 US cents and Mr Poloz slowing the pace of hikes if Mr Trump ultimately quits.

"What isn't clear is whether six months down the road this means the end of Nafta, or does Congress stall, does Canada play for time? It certainly throws enough doubt on Nafta that it could affect capital spending plans this year."

BLOOMBERG