08:26 AM EST, 03/07/2025 (MT Newswires) -- The United States Trump administration has followed through on earlier threats and introduced a 25% tariff on Canadian and Mexican exports to the U.S., with only 10% on Canadian energy, noted UBS.

To ease tensions, President Donald Trump carved out an exemption for the car industry, which would come under immense pressure otherwise. While the bank sees a higher risk of a very aggressive tariff scenario, it thinks Canadian and Mexican tariffs won't be sustained -- the pressure on the U.S. economy would be too high.

However, this will require concessions by Canada and Mexico such as more spending on border security and

defense, tariffs on Chinese exports to limit transshipment of Chinese goods, or a deal on critical minerals, which Canada has a lot of, stated UBS.

How is the Canadian dollar's (CAD or loonie) outlook affected by the developments, asked the bank. Tariffs will have a vast negative effect on Canadian growth -- more so than inflation.

Arguably, some damage has already been done given the long period of uncertainty and stockpiling by U.S. companies skewing the picture, wrote the bank in a note to clients. The latest PMI survey results indicated this and will continue to do so should tariffs remain in place.

The Bank of Canada noted that it is ready to act -- in other words, lower rates to support growth -- in a tariffs scenario. UBS thinks this will be the case next week and the policy rate will be cut to 2.75%.

This would hurt the CAD, added the bank. However, so far, the currency has largely shrugged off risks of a major tariff-related escalation and the risk premium -- similarly to the February tariff deadline -- has been benign.

While UBS doesn't see tariffs staying in place as they are, it argues that a bigger risk premium would be warranted and sees short-term downside risks to the CAD. USDCAD revisiting the 1.45-46 highs cannot be ruled out in the coming weeks.

Later in the year, however, the bank thinks the pair will fall in line with broader US dollar (USD) weakness. UBS also sees a modest rise in more risk betaneutral expressions such as AUDCAD. Lastly, it likes selling the downside in USDCAD.