Monetary Policy Report—July 2026—In focus
The conflict in the Middle East has generated both direct and indirect cost pressures that continue to feed through supply chains. These cost pressures are material for the inflation outlook.
The war in the Middle East has disrupted oil production and shipments, pushing energy and other commodity prices sharply higher.
In the base‑case projection, the peak impact of higher gasoline prices adds roughly 1.4 percentage points to inflation in the second quarter of 2026. In addition, businesses are assumed to pass on some of the war‑related costs from earlier this year rather than absorb them entirely through lower margins. These additional cost pressures are projected to have a peak impact of about 0.4 percentage points on consumer price index inflation in the first quarter of 2027.
Upstream cost pressures pose a challenge for businesses
Upstream costs include the raw materials, components and services that businesses need to produce a good or service. When these costs come under pressure, it takes time for the effects to move through the supply chain. Ultimately, these cost pressures squeeze profit margins and can force businesses to raise their prices.
How much these cost pressures affect inflation depends on two factors:
- how long they remain elevated
- how much of them businesses pass through to consumer prices
In the United States, where upstream and downstream price pressures can be tracked closely, upstream prices have risen in some sectors, while pass‑through to final consumer prices has so far been limited (Chart 22).
How long cost pressures last will affect inflation
The persistence of upstream cost pressures is important for the inflation outlook. The Bank of Canada is monitoring a variety of indicators to assess whether cost pressures are likely to persist. The indicators capture four channels through which the war could affect upstream costs:
- Supply chain bottlenecks. It may take time for traffic through the Strait of Hormuz to return to pre‑war levels. Volumes in key ports are being monitored for signs that shipping disruptions are easing. Bank of Canada surveys of businesses are providing additional insights.
- Elevated transportation costs. Shipping costs could remain above pre‑war levels until routes through the region are seen as safe and reliable. Data on key shipping routes, including major container traffic between Shanghai and Los Angeles, provide a gauge of whether transportation cost pressures are normalizing.
- Longer‑term supply shortages. Even after shipping returns to normal, some commodity production may be slow to recover due to war‑related damage to infrastructure. Price indicators for these commodities help assess whether supply constraints are keeping input costs elevated.
- Additional short‑term demand pressures. Inventories of war‑affected commodities have been drawn down during the conflict, and restocking could add to demand pressures in the near term. Oil and natural gas inventories and prices are being monitored.
To date, several indicators point to elevated cost pressures related to the war (Chart 23). For example:
- Global supplier delivery times have lengthened because some imported goods have become harder to source and because businesses have purchased inputs in advance to avoid further cost increases. Survey results show that the number of businesses in Canada reporting supply chain issues has risen, although most said their ability to meet demand has not been limited.
- Shipping costs have increased.
- Prices of commodities such as diesel, aluminum and jet fuel are elevated.
How much is passed through to consumers can vary
Canadian businesses face a difficult choice on cost pass‑through.
On the one hand, if disruptions prove short‑lived, businesses that quickly pass on costs risk losing market share to competitors that do not. On the other hand, if businesses hold prices steady and cost pressures remain elevated, their profit margins will narrow.
The ability to raise prices is affected by weak demand in the Canadian economy.