07:22 AM EST, 01/29/2025 (MT Newswires) -- The Canadian dollar (CAD) is the second worst-performing G10 currency so far this year and the only surprise in that is that sterling is performing worse, said Mitsubishi UFG.

The bank sees "clear" downside risks for CAD with signs since President Donald Trump's inauguration certainly clearly pointing to a greater focus on trade tariffs being implemented on both Canada and Mexico imports to the United States.

The Bank of Canada meets Wednesday and given this backdrop of a clear risk of a trade shock for the Canadian economy, MUFG expects the BoC to deliver the 25bps cut to the policy rate that is widely expected. A 25bps reduction is close to fully priced and given the clear negative consequences for the economy if Trump does deliver on his plan for trade tariffs of up to 25%, the Canadian economy will need additional policy support.

Real gross domestic product in Q4 2024 in fact is looking like it will surpass the BoC estimate of 2.0%, by as much as 0.5ppt, wrote the bank in a note to clients. Inflation has also proved a little higher than the BoC expected -- 2.6% year over year versus 2.3% expected.

The latest inflation reading was weaker than expected but a tax holiday certainly played a role in that. But these divergences won't be enough to deter the BoC especially given there are grounds for believing that growth may have got a lift from Canadian companies increasing exports in an attempt to avoid the expected trade tariffs, stated MUFG.

However, for the BoC, this meeting will really be dictated to a high degree by the uncertainty over the immediate economic outlook given the 25% tariff threat from this Saturday remains in place and would in the bank's opinion prove net disinflationary.

Canada's retaliation would have inflationary consequences but the demand hit and the potential labor market impact would be clearly deflationary and that for now will likely take precedence in BoC policy deliberations, according to MUFG. The increased supply of labor will continue to help ease wage growth -- the unemployment rate hit a high of 6.9% in November, the highest level since January 2017 -- excluding COVID-19.

USD/CAD is certainly not trading to reflect the implementation of a 25% trade tariff on all imports by this weekend, pointed out the bank. So there remains a high level of skepticism over this policy threat being delivered.

Based on data since the start of 2022 USD/CAD is trading exactly where it should be based on the two-year U.S.-Canada swap spread, added MUFG. That spread will certainly move further wider if trade tariffs are confirmed and the bank suspects comments from Governor Tiff Macklem on Wednesday will indicate greater growth concerns over inflation concerns related to tariff risks that would be a signal of a willingness to ease further if a trade shock is around the corner.

A break of the 1.4500 resistance would be immediate with a move quickly to the 1.5000 level and beyond. So Trump's decision will be far more important for CAD than Wednesday's BoC decision, noted MUFG.