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On balance, the 20 per cent tax on imports, the key tenet of a GOP proposal Trump has reportedly warmed to, would “depress Canadian exports by 8 per cent,” he estimates.

And Canada’s fiscal-policy levers to respond to protectionism might be more limited than you’d expect, argues Galy. The federal value-added tax — which functions in a similar manner to a border-adjustment tax — was already trimmed to 5 per cent by Prime Minister Justin Trudeau’s predecessor, Stephen Harper.

Which leaves the Bank of Canada.

Monetary easing isn’t something that traders see in the cards. Overnight index swaps suggest markets are betting tightening is more likely than easing this year, with the odds of a cut peaking at just 3.5 per cent for April’s meeting.

Indeed, the story in markets since the November election has been one of convergence, much to Bank of Canada Governor Stephen Poloz’s chagrin.

The governor cited Canada’s historically strong financial and economic links to its southern neighbour as the cause of the rises in the dollar and government bond yields, which have been highly correlated to their U.S. counterparts in recent months.

On Tuesday, the U.S. dollar fell below 1.30 Canadian for the first time since September.

Poloz deemed the lofty loonie as a headwind for exports — but this rewriting of Canada’s terms of trade by way of a U.S. border-adjustment tax could have a far more precipitous effect on southbound shipments. In theory, currency markets would quickly adjust to fully offset the relative change in prices caused by the shift in U.S. tax policy. But the Bank of Canada won’t be content to rely on the textbooks, Galy reckons, and will need to respond with action and words — cutting its benchmark interest rate to 0.25 per cent and threatening to pursue unconventional asset purchases “when the U.S. measures become highly probable.”

This combination would be enough to push the Canadian dollar 10 per cent lower and protect the competitiveness of the nation’s exports, he estimated.

“The threat of quantitative easing would drive a wedge between Canada’s and U.S. Treasury that would mechanically depress the currency,” Galy said.

Bloomberg.com