07:10 AM EST, 03/04/2025 (MT Newswires) -- The Canadian dollar (CAD or loonie) and Mexican peso (MNX) have continued to trade at weaker levels overnight Monday after United States President Donald Trump decided to implement 25% tariff hikes on imports from Canada and Mexico with the only exception being the lower 10% tariff rate on imports of energy from Canada, said MUFG.

In addition, Trump decided to put in place another 10% tariff hike on imports from China. It represents a significant escalation in the global trade war during President Trump's second term, wrote the bank in a note to clients.

Bloomberg reported that the tariffs will apply to around $1.5 trillion of annual imports into the U.S.. Up until this point, Trump had only put in place a 10% tariff hike on imports from China that became effective from Feb. 4.

It has resulted in the USD/CAD rising back above the 1.4500 level overnight Monday and USD/MXN rising up closer to the 21.000 level, stated MUFG. The size of initial moves lower for the Canadian dollar and Mexican peso have been relatively "modes"t considering the scale of the tariffs that have been put in place.

The price action suggests that market participants remain hopeful that the tariff hikes won't remain in place for long, helping to limit trade and economic disruption, pointed out the bank. The longer the tariffs are in place, the more likely that both Canada's and Mexico's economies will slow sharply and fall into recession.

It will increase pressure on the Bank of Canada and Mexico's central bank (Banxico) to cut rates more deeply to provide support for economic growth, reinforcing the sell-off for the Canadian dollar and Mexican peso, added MUFG.

The bank continues to believe that both currencies could fall by around 5%-10% in response to more persistent tariff hikes. It poses downside risks to MUFG's forecasts.

Part of the negative impact on the Canadian dollar, Chinese renminbi and Mexican peso from the U.S. tariff hikes will be offset by retaliatory action and evidence of slowing economic growth in the U.S. at the start of this year, according to the bank.

Canadian Prime Minister Justin Trudeau stated that "Canada will not let this unjustified decision go unanswered" alongside plans to put in place retaliatory tariffs on imports from the U.S. The plan was initially announced back in February and involves two stages.

In the first stage, Canada has applied 25% tariffs on about C$30 billion of imports. In the second stage, Canada will apply a 25% tariff on C$125 billion of imports in three weeks time, including on big-ticket items like cars, trucks, steel and aluminium. The two-stage approach for retaliatory tariffs highlights that the Canadian government is holding out hope that a deal can still be reached with President Trump to reverse tariff hikes in the coming weeks.

PM Trudeau confirmed that Canada's tariffs will remain in place until U.S. trade action is withdrawn, while threatening to pursue several non-tariff measures as well to hit back if the U.S. tariffs don't cease. Non-tariff measures under discussion include limiting or shutting out U.S. companies from government contracts.

China also announced another targeted package of retaliatory trade measures against the U.S. overnight. The measures include placing tariffs as high as 15% on U.S. agricultural goods, including on chicken and cotton. Soybeans, beef and fruits are among U.S. imports facing a 10% tariffs.

The Chinese tariffs will take effect next Monday. In addition, China has stated that it will put 10 American companies on an unreliable entity list, mainly those involved in defense work. It also added 15 firms, including defense contractors General Dynamics Land Systems and Skydio Inc., to an export control list.

The measure to prevent exports to those companies is a new step by China and comes after it banned the sale of dual-use goods to the U.S. military in December and the export of some dual-use metals such as gallum and germanium to all U.S. entities.

Market participants will be watching even more closely this week's annual National People's Congress (NPC) to assess China's plans for further stimulus to support domestic demand going forward and provide an offset to the hit to external demand. MUFG continues to expect China to allow the renminbi to weaken more against the US dollar (USD) to help provide an offset as well.

Now that President Trump has followed through with his threat to put more disruptive tariffs in place, it increases the risk that he will take further action in the coming months, according to the bank.

Trumo is already planning to put in place: i) 25% tariffs on steel and aluminium imports from March 12; ii) 25% tariff on imports from the European Union from April 2; iii) 25% tariffs on imports of autos, pharmaceuticals and semiconductors from April 2; iv) unspecified "reciprocal tariffs" against all imports from April 2; and v) unspecified tariffs on imports of copper from Nov. 22.

Trump added to that list overnight plans to impose tariffs on "external" agricultural products from April 2. The U.S. Department of Agriculture forecast only last week that the U.S. trade deficit for agricultural products is set to widen to a record $49 billion this year.

The plans highlight that Trump is planning a structural shift in the global trading system, noted MUFG. It's one reason why the bank remains reluctant to drop its call for a stronger US dollar even after weakness at the start of this year.

However, MUFG's updated forecasts were pared back to reflect less upside potential for the US dollar to better reflect recent weakness in the U.S. economy at the start of this year. Rising optimism over a ceasefire deal in the Russia-Ukraine war and a significant step up in government spending in Europe has also helped to provide more support for European currencies at the start of this year helping to dampen upside potential for the US dollar as the bank saw again Monday when EUR/USD rose back above the 1.0500 level.

As a result, MUFG has pulled its forecast for EUR/USD to drop back below parity.