The heightened uncertainty following the collapse of Canada-US trade talks strengthens the Bank of Canada's case for keeping interest rates on hold, according to BMO Capital Markets senior economists Robert Kavcic and Jennifer Lee in a Monday note.
New US tariffs, which took effect Saturday on certain Canadian goods, are expected to push inflation higher, but the pass-through should remain manageable for the BoC given Canada's low underlying inflation, economists said.
"We do not expect the broader macroeconomic impact of these new tariffs to be enough to push the Bank of Canada to seriously consider pivoting to interest rate cuts," wrote RBC Economics in a Saturday note.
Late Friday, Canadian Prime Minister Mark Carney suspended talks on new specific US tariffs, saying last-minute changes to US proposals were "unfair" and "uneconomic." The US blamed Canada for the end of the talks, adding that Carney rejected terms agreed earlier in the week.
While Canadian retaliatory tariffs could add to inflationary pressures, previous rounds had only a minimal impact on the consumer price index, raising it by just a few decimal points at their peak. Their impact was largely a one-time increase in the price level, rather than a persistent source of inflation, according to economists.
"We would expect a similarly minimal inflation impact in this case, and therefore, a potential for this trade-war escalation to keep interest rates low for longer if growth is negatively impacted," wrote CIBC Capital Markets economists Avery Shenfeld and Andrew Grantham in a Sunday note.
The BoC's annual core inflation measures averaged 2.0% in July, while the traditional measure excluding food and energy came in at 1.9%. Both measures remained comfortably within the BoC's target range.
Trade tensions have been one reason the BoC has refrained from responding to the energy-driven rise in headline inflation this year, and UBS Global Research economists said in a Monday note that they think the latest developments further reinforce the case for keeping rates on hold.
Most economists believe the growth impact will outweigh any upward inflation pressure, although the case for the a greater central bank scope for rate cuts has strengthened.
"Over the medium term, however, a weaker growth backdrop tilts the risks to a slightly more dovish skew, as the BoC specifically noted worsening tariffs as a potential reason to lower rates further," added BMO's economists.