Key Takeaways
- The inflation spike amid the Iran war has dampened expectations of interest rate cuts.
- Analysts say a short-lived war and contained economic disruption will likely keep the Bank of Canada on hold.
- A prolonged conflict and its economic fallout could make things challenging for the central bank.
As the war in Iran enters its second week, the resulting surge in oil prices and its inflationary impact raise a key question: How will the war affect the Bank of Canada’s policy? Surging crude prices risk feeding into inflation, potentially complicating the central bank’s efforts to keep price pressures under control while supporting a fragile economy. But most analysts expect the Bank of Canada to keep rates on hold, adopting a wait-and-see stance.
Oil prices have soared since the war broke out on Feb. 28. Brent crude briefly topped USD 100 on Monday before slipping and stabilizing just below USD 90 per barrel. The inflationary sting was felt almost immediately at the pump, and higher fuel costs could soon ripple to other areas of the economy.
For policymakers, the key issue is whether the energy shock is a temporary disruption or proves more persistent. Analysts say the Bank of Canada will likely look through the short-term impact of elevated oil prices and keep interest rates on hold. But a protracted conflict (and the risk of widespread second-round inflationary pressures) could complicate the policy outlook.
Many analysts are hoping for a more optimistic scenario in which the conflict is short-lived and the economic damage remains limited. In that case, the Bank of Canada will likely wait for the inflationary effects to fade while remaining on the sidelines, where it has been since December.
“For now, we’re sticking with our call of the Bank of Canada staying on hold through this year, with the war limiting the risk of further easing,” says Shelly Kaushik, senior economist at BMO Economics. “The Bank will likely stress that the oil price shock is out of its control, so it will try to look through the volatility unless it turns into a more sustained conflict.”
The Bank of Canada enacted four rate cuts totaling 100 basis points in 2025, bringing its policy rate down to 2.25%. That’s the bottom of its neutral range (the level at which monetary policy is considered neither stimulative nor restrictive).
A Short-Lived War Would Keep the Policy rate Unchanged
Tiago Figueiredo, macro strategist at Desjardins Capital Markets, echoes the prevailing sentiment among analysts, who expect the war and its inflationary effects to be short-lived. “Policymakers have the flexibility to wait on the sidelines, and they are likely to do so,” he says. “Unless the energy price shock becomes more entrenched or inflation expectations become unmoored, the Bank of Canada will likely try to look through the impact of higher oil prices.”
For the short term, Figueiredo says that “higher energy prices tend to lift Canadian GDP,” since a larger share of the country’s economy is tied to energy production. And while they could drive up consumer prices, “in Canada, inflation is starting from a lower point.”
BMO’s Kaushik says it’s too early to tell how long the inflation impact will last. “The most recent inflation and GDP figures were on the soft side, so there was a small risk of further cuts,” she says. For now, she thinks the Bank will justify its decision to remain on hold by pointing out that “the oil price shock is out of its control.” All told, Kaushik believes the odds of a rate cut this year, while not zero, are quite low, unless the conflict escalates.
A Sustained Conflict Would Complicate the Picture
There’s a growing consensus among analysts that a drawn-out war could cloud the outlook and pose additional challenges for the Bank of Canada.
Prolonged negative energy supply shocks are particularly difficult, as they lead to weaker economic activity and higher interest rates, according to Charles St-Arnaud, chief economist at Servus Credit Union. “There is not much that central banks can do with monetary policy to reverse these shocks,” he says. “The Bank of Canada, whose mandate is inflation, will need to focus on reducing inflationary pressures [by] increasing their policy rate to slow demand and increase the amount of excess supply in the economy.”
He explains that a rate hike resulting from a prolonged war and sustained oil shock would deliver a one-two punch to the economy: higher energy prices and higher interest rates to fight inflation. The longer that energy prices remain elevated and feed into other costs, “the greater the likelihood that the Bank of Canada will raise interest rates to ease inflationary pressures.”
BMO’s Kaushik says her base case assumes a limited disruption to the Strait of Hormuz, a key chokepoint for global oil flow. Still, she warns that “the risks of a more prolonged conflict have risen in recent days.” She is watching the developments in the Middle East, with “a close eye on the damage to regional energy infrastructure across many Gulf countries, estimates of Iran’s weapons stockpiles, and a longer closure of the Strait of Hormuz” to assess their implications for the Canadian economy.
The Bank Is Preparing for Multiple Scenarios
Analysts say the Bank of Canada is gearing up for various outcomes to calibrate its policy response. “My sense is that the economists at the Bank of Canada have already prepared for a number of different scenarios and are prepared for several different contingencies,” says RSM chief economist Joe Brusuelas. He says the Bank’s calculations include, among other scenarios, “an extended war that puts a significant constraint on global oil, natural gas, condensates, and liquids out of the Persian Gulf.”
The Bank’s short-term scenario incorporates “a wait-and-see mode” says Servus’ St-Arnaud. But the longer the energy flow disruption lasts, the bigger the impact will be on the global economy, he adds. “[Policymakers] will be closely monitoring whether higher energy prices are filtering through other prices. If they do, they could hike, but such an action would take time and is very unlikely until at least the summer.”
