Oil Price Surge from Iran Conflict Could Fuel Canada's Economic Growth and Inflation
A sustained increase in oil prices, driven by the ongoing war in Iran, has the potential to significantly boost Canada's economic growth and inflation outlook, according to a recent analysis from Bank of Nova Scotia. As a major crude-producing nation, Canada stands to benefit from higher petroleum prices, which could enhance export earnings relative to import costs.
Economic Impact of a Persistent Oil Price Rise
Olivier Gervais, director of modeling and forecasting at Scotiabank, detailed that a persistent US$10-per-barrel increase in the price of West Texas Intermediate (WTI) crude would result in Canada's real gross domestic product (GDP) being 0.5% higher by the end of 2027. "Higher oil prices represent a sizeable nominal income transfer into Canada. Energy sector profits and investment rise, supporting employment and eventually household spending," Gervais stated in a report released on Monday.
This economic lift, however, would be partially offset by weaker household purchasing power due to rising gasoline prices. While core inflation is expected to remain relatively contained, the consumer price index could increase by 0.2 percentage points by 2027. Additionally, the Canadian dollar might appreciate by approximately three percent, which would dampen imported inflation but weigh on non-energy exports.
Policy Implications and Central Bank Challenges
The analysis suggests that the Bank of Canada's policy rate could be 30 basis points higher by the end of the next year, reflecting the complex interplay of supply shocks. Deputy Governor Sharon Kozicki emphasized in a speech that central bank decision-making becomes more intricate during such periods, as supply shocks can simultaneously pressure both growth and prices.
Currently, the Bank of Canada projects inflation to hover near the two percent target over the next couple of years and has indicated comfort with maintaining the overnight rate at 2.25%. This stance comes as the economy adjusts to structural changes from ongoing trade disputes, which have already strained exports and business investment. Despite firmer domestic demand in the fourth quarter, output contracted at a 0.6% annualized pace due to inventory drawdowns.
Market Reactions and Future Outlook
Traders in overnight swaps are betting that interest rates will remain stable through 2026, though pricing for hikes has edged higher since the escalation of the Middle East conflict. Andrew Kelvin, head of Canadian and global rate strategy at Toronto-Dominion Bank, noted, "A move higher in oil prices lowers the risk of the Bank of Canada cutting rates this year." Concurrently, Canada's bonds have sold off across the curve.
Oil prices surged the most in four years as initial impacts of the war emerged, including a near-halt to traffic through the Strait of Hormuz and disruptions at a major refinery in Saudi Arabia, highlighting threats to global supplies. West Texas Intermediate traded above US$70 per barrel in early afternoon trading on Monday. Canadian crude is anticipated to outperform U.S. benchmarks as refiners seek alternatives to sour grades from the Middle East, such as those from Iraq and Saudi Arabia.
This scenario underscores the broader economic challenges and opportunities for Canada amid geopolitical tensions, with potential ripple effects on growth, inflation, and monetary policy in the coming years.
