07:40 AM EDT, 08/05/2025 (MT Newswires) -- Last week, there was yet another era in the ever-changing Canada-United States trade relationship, said Bank of Montreal (BMO).

With no deal reached by last Friday, the 'fentanyl' tariffs on non-CUSMA-compliant goods to the U.S. went from 25% to 35%.

The bank's initial read is that this won't have a meaningful short-term impact on the economy. BMO estimates that about 90% of Canadian goods exports to the U.S. are CUSMA-compliant. But, the odds of a trade deal to bring some degree of certainty -- let alone any relief on tough sectoral tariffs -- remain up in the air.

BMO awaits the threatened retaliation from the Canadian government, as it had hinted at back when steel and aluminum tariffs were bumped up to 50%.

Over the medium term is when things get more complicated: just how close are we to a deal, and what would further escalation look like? Will the fentanyl (and 'reciprocal') tariffs survive U.S. court challenges? Does the reliance on CUSMA exemptions make Canada particularly desperate during renegotiations on that deal?

In the meantime, Canadian and Mexican officials are meeting for bilateral talks this week, while Prime Minister Mark Carney and President Donald Trump are expected to speak in coming days.

Against this backdrop, and ahead of last Friday, the Bank of Canada remained on hold for the third straight meeting. The updated Monetary Policy Report included a sharp 1.5% annualized economic contraction in Q2 -- which suggests it will be tough for the GDP report to disappoint.

The following day, the economy was confirmed to have shrunk 0.1% month over month in May, for the second straight month, though the preliminary estimate for June was for a 0.1% month-over-month recovery. The flash estimate for Q2 suggested a 0.1% a.r. gain, which is certainly a pleasant surprise, but doesn't take a negative print off the table for the quarterly release at the end of the month.

Altogether, BMO continues to expect a 0.8% annualized contraction in Q2, but it revised up its call for Q3 to flat. In other words, the bank is no longer expecting a 'technical' recession.

To be sure, economic growth is still soft -- expected at just 1.3% this year -- but, again, the BoC is expecting that. It will need to see inflation pressures cool before it can be comfortable cutting again, and that might be a high bar for September.

The Canadian dollar (CAD or loonie), after strengthening a touch over the weekend, is 0.2% weaker against the US dollar (USD) and hovering around $1.38 (72.4 cents US), pointed out the bank.

There are a couple more key reports to watch this week. Tuesday at 8:30 a.m. ET, the merchandise trade deficit looks to widen further in June, added BMO. Lower U.S. import data point to broad weakness in Canadian shipments to that country, while the May surge in gold exports to the United Kingdom is unlikely to be repeated. On the flip side, higher energy prices will prop up the value of energy exports. Merchandise trade flows will continue to face pressure in the absence of a firm trade deal.

On Friday, the July Labour Force Survey (LFS) is expected to show employment growth returning to its lackluster pace following July's outsized gain. The bank is looking for the unemployment rate to return to 7.0%, matching May for the highest since 2021, and wage growth to remain on a downtrend.

This LFS will be the first look at how the economy fared in July, so BMO will be watching hours worked for clues on whether the better-than-expected momentum at the end of the quarter held up to start Q3.