The Bank of Canada launched a pre-emptive strike on inflation this morning, raising borrowing costs by a quarter percentage point in an effort to prevent price pressures from spreading across the economy as the global energy shock rumbles on.
A rise in inflation risks played a decisive role. In the official statement setting out the decision to raise the benchmark rate to 2.5%, policymakers said the “conflict in the Middle East is now in its eighth month and there is no clear path to resolution,” and warned “cost pressures are building,” with higher-for-longer energy prices raising input costs and lifting inflation expectations. Headline inflation is seen climbing to 3.5% over the coming months as energy prices feed through, with officials forecasting persistently-hot price growth through much of 2027.
Growth expectations were also revised higher. Updated projections showed the Bank’s economists think the economy will grow 1% this year before accelerating to 2% in 2027 and 2028.
Governor Tiff Macklem balanced optimism on the economy with caution on price pressures. In remarks released ahead of the post-decision press conference, the governor said “Growth will likely slow in the fourth quarter as new US tariffs weigh on activity,” he said, but “should pick up again in 2027 as consumer spending continues, exports pick up and business investment strengthens, supported by fiscal measures”. At the same time, “the longer energy prices remain high, the more likely it is these costs will spill over to consumer prices more broadly”. Looking ahead, he said, we “agreed we would take future decisions one meeting at a time. There could be a need to raise the policy rate further, but given the uncertainties, we will proceed carefully”.
The Canadian dollar is advancing against its G10 peers amid volatile price action, suggesting that traders are struggling to reconcile the impact that higher borrowing costs could have on a still-weak domestic economy. Although we are bullish on the loonie over longer horizons, we remain convinced that markets are overpricing the Bank’s tightening trajectory, and expect a bout of weakness before the end of the year as implied rate differentials widen against the currency again.
