UPDATE 2-Canada makes clear Boeing must back down if it wants jet order

(Adds details, quote from government minister, background)

OTTAWA, Dec 12 (Reuters) - Canada on Tuesday scrapped plans to buy 18 Boeing Co jets and made clear the company had little chance of winning a larger contract for 88 fighters unless it dropped a challenge against planemaker Bombardier Inc.

The announcement marks a new low in relations between the Liberal government and Boeing and casts into doubt the future of defense cooperation with the U.S. aerospace giant.

Canada announced last year it wanted to buy the Boeing jets as a stopgap measure to allow Ottawa to run a competition for 88 jets to replace its aging 77 CF-18s fighters.

Instead Ottawa will now buy a second-hand fleet of 18 Australian F-18s, the same planes the Canadian air force already operates. The value of the deal is set to be around C$500 million ($388 million).

In a clear reference to Boeing, Carla Qualtrough, public works and procurement minister, told a news conference on Tuesday that "bidders responsible for harming Canada's economic interests will be at a distinct disadvantage" compared to other companies taking part in the competition for the 88 jets.

Reuters reported last week that the Liberal government would abandon the plan for the 18 Boeing jets after the U.S. aerospace giant launched a trade challenge against Canadian plane maker Bombardier Inc, accusing it of dumping airliners on the American market.

Qualtrough said the competition would be open and no companies would be excluded.

Innovation Minister Navdeep Bain did not respond directly when asked at the news conference whether Boeing could improve its chances of winning the order for 88 jets by bowing to a Canadian government demand to drop the trade challenge.

The cost of the 88 jets is estimated at C$15 billion to C$19 billion, according to Canadian officials.

If Boeing is excluded, potential winners include Lockheed Martin Corp, Dassault Aviation SA and Airbus SE.

Representatives of Boeing, Airbus and Lockheed Martin were not immediately available for comment.

The air force has long preferred a U.S. jet, according to Canadian defense sources. Canada is part of the consortium that helped develop Lockheed Martin's F-35 stealth fighter and the previous Conservative government announced in 2010 it would buy 65 of the planes.

It later backtracked and during the 2015 election campaign Trudeau vowed not to buy the fighter on the grounds it was too expensive. After he took power, the government subsequently softened its tone and said the F-35 would be allowed to compete. ($1 = 1.2873 Canadian dollars) (Reporting by David Ljunggren and Andrea Hopkins; Editing by Susan Thomas and Jeffrey Benkoe)