By Fergal Smith and Leah Schnurr
TORONTO/OTTAWA (Reuters) - Canada's commodity-linked economy will suffer weaker growth because of Britain's vote to leave the European Union, which has put the prospect of Canadian interest rate cuts back on the table.
The vote is also seen delaying the ratification of a long-negotiated free trade deal with the EU, and fueling a housing market boom in Vancouver and Toronto that some worry is turning into a bubble.
Economists warned Brexit's biggest impact on Canada will come through its disruption of global trade and investment, which would weaken the price of oil and other Canadian exports.
That prospect drove the Canadian dollar down more than 2 percent on Friday, while Toronto's main stock index fell 1 percent and bond prices rose. Oil prices fell about 5 percent in New York. [CAD/] [O/R]
"Canada's direct exposure to the UK is fairly limited, but indirectly the financial volatility following the Brexit vote will put downward pressure on commodity prices and deepen the downturn in Canada's resource sectors," said William Adams, senior international economist at PNC Financial Services Group.
Canada sold C$16.6 billion ($12.81 billion) of goods, or about 3 percent of its exports, into the UK last year, making it the biggest buyer after the United States and China. Canadian companies, including Bombardier <BBDb.TO>, also have major investments there.
TD Bank estimated the exit vote could shave about 0.5 to 1.0 percentage point off economic growth in Canada and the United States in the second half of the year.
TD said the Canadian provinces most likely to feel the brunt of reduced UK demand are Newfoundland & Labrador, which ships about 8 percent of its goods to the UK, and Ontario, which sends about 6 percent.
RATE CUTS BACK IN PLAY
Canada's economy was already struggling to gain momentum after being pushed into a mild recession in early 2015 by the collapse of oil prices. The Bank of Canada cut interest rates twice last year to offset the damage.
Expectations of further policy easing had faded this year as oil prices pared some losses and Bank of Canada officials began to sound more optimistic.
That changed Friday after the British vote with overnight index swaps, which track expectations for the central bank's main policy rate, now implying a 27 percent chance of a cut this year. Swaps were priced for no change before the Brexit result. <BOCWATCH>
"The risk is still that the bank could conceivably cut," said David Tulk, chief Canada macro strategist at TD Securities, who notes he is not forecasting a lowering of interest rates.
Lower borrowing costs could further lift Canadian property prices already at record highs, a trend has worried policymakers.
"Do you really need fuel on that fire? Probably not," said Sherry Cooper, chief economist with Dominion Lending Centres.
The vote could also pull global money out of real estate holdings in the United Kingdom and Europe and into countries seen as more stable.
"In that respect, Canada would be an attractive option for them," said Brad Henderson, chief executive of Sotheby's Canada.
Foreign buying is often cited as a factor in Canada's housing boom.
TRADE DEAL RISK
Prime Minister Justin Trudeau said Canada would continue to build relations with Britain and the EU, adding Canada was well-positioned to weather market uncertainty.
Canada's free trade agreement with the EU, known as the Comprehensive Economic and Trade Agreement (CETA), still needs to be formally signed, something both sides had hoped would happen this year.
Trade Minister Chrystia Freeland said she reiterated Canada's commitment to the deal with her EU counterpart early on Friday.
A joint Canada-EU study found the deal could boost Canada's income by C$12 billion annually and lift bilateral trade by 20 percent.
"This (Brexit) pretty much guarantees that it will be pushed back," said Mark Warner, an international trade lawyer. "I don't think it ends CETA."
Last month, Trudeau told Reuters that there would be "nothing easy or automatic" about negotiating new trade deals with Britain if it left the EU.
Asked about the possibility of a separate UK free trade deal, a spokesman for Freeland declined to comment, but said it was "worth remembering the strong and existing economic relationship between Canada and the UK."
(With additional reporting by Jeffrey Hodgson in Toronto and Julie Gordon in Vancouver; Editing by Alan Crosby)