What’s Driving Inflation: Tariffs, Spending, or Gas Prices?

MPs returned to the House of Commons earlier this month to confront a familiar challenge—rising prices—but the drivers behind inflation today have shifted. Many Canadians are still coping with the aftereffects of the post-pandemic surge in costs for housing, fuel and groceries. Yet the forces shaping inflation now include policy choices such as tariffs, tax measures and government spending, and both lawmakers and the Bank of Canada are weighing how those factors are affecting the cost of living.

Below is a clear summary of the current inflation picture in Canada and what to watch in the months ahead.

Moderate uptick in inflation, but policymakers are watching longer-term trends

Statistics Canada reported annual inflation at 1.9% in August, up from 1.7% in July. The Bank of Canada targets 2% annual inflation as its benchmark for price stability. A one-month increase of this size is not necessarily alarming: Mostafa Askari, chief economist at the Institute of Fiscal Studies and Democracy and the University of Ottawa, notes that policy-makers typically look at trends over several months before changing course. A single monthly fluctuation is best interpreted in the context of longer-term movements.

Relief at the pumps and on mortgages, but groceries remain stubborn

Several factors have eased inflationary pressure recently. The federal government ended the consumer carbon price in April 2024, which has translated into lower prices at the gas pump compared with a year earlier and has influenced year-over-year comparisons. Shelter inflation is cooling too, as slower population growth reduces pressure on rental markets in many cities. Meanwhile, mortgage rates have eased from last year’s highs: borrowers shopping for a five-year fixed rate today are seeing levels closer to 4%, down from rates above 5% at the same time last year.

Food prices remain a source of pain for shoppers. Statistics Canada reported food inflation at 3.4% in August—well below the double-digit increases seen during the height of the inflationary spike but still elevated compared with headline inflation. Askari explains that prices often climb quickly when inflation rises but can be “sticky” on the way down, meaning consumers continue to feel the cumulative impact of prior price increases at grocery stores.

Tariffs and weather add volatility to food costs; relief is emerging

Grocery inflation is influenced not only by domestic conditions but also by trade and weather. Canada’s retaliatory tariffs on some U.S. goods raised costs for firms importing inputs, which can be passed into final prices—especially for perishable items like orange juice. At the same time, fresh food prices are sensitive to global weather and growing conditions, which makes it difficult to isolate how much of recent price moves are directly tied to tariffs.

Earlier this month, Canada removed most of the retaliatory tariffs on U.S. goods. Economists, including Randall Bartlett of Desjardins, expect that removing these counter-tariffs and the consumer carbon price will lower headline inflation by a meaningful margin in 2026 compared with a scenario where those policies remained in place. However, the effect of tariffs already applied will still influence September’s readings and then fade gradually as those costs work through supply chains.

Deficit spending and inflation: context matters

Conservative Leader Pierre Poilievre has argued that federal deficits are driving inflation. Experts caution that the relationship is more nuanced. Askari explains that when government spending puts more money directly into the hands of households or businesses, it can stimulate demand and raise prices if supply does not respond at the same pace. But when spending is directed at expanding supply—such as investments that increase housing stock—those measures can reduce inflationary pressures over time.

Canada’s economy contracted in the second quarter, and most forecasters expect a modest rebound. Bartlett notes this suggests slack remains in the economy, meaning well-targeted fiscal stimulus could support growth without necessarily igniting a pronounced jump in inflation. That said, near-term risks exist: large capital investments that sharply increase demand for construction labour or materials could be inflationary in the short run, even if they improve productivity and ease price pressures in the medium to long term.

Plans to reduce federal operating spending by as much as 15% over three years, if implemented, would have a disinflationary effect, while the actual inflationary or disinflationary impact of planned capital investments will depend on how effectively those funds raise productive capacity.

New federal spending will be factored into forecasts after the fall budget

The Bank of Canada has been monitoring inflation closely, including the effects of trade disputes, and recently trimmed its policy rate to 2.5%. Governor Tiff Macklem has said the balance of risks has shifted toward a weakening economy rather than accelerating inflation. The Bank has not yet reflected the federal government’s recent spending announcements in its projections; it will incorporate those measures once the federal budget is published on Nov. 4, shortly after the Bank’s next interest-rate decision.

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