Bank of Canada raises rate to 2.50%, vows cautious approach

• Traders had assigned a 78% probability to a rate increase.
• The overnight rate stood at 2.25% before the decision.
• The Bank stated that inflation is both elevated and stickier than projected in its July report.
• Global economic activity has shown resilience even amid elevated energy costs.
• Economic growth has accelerated this year and is anticipated to continue strengthening.
• Further rate increases may be necessary, but given the high level of uncertainty, the Governing Council decided to move cautiously.

The final point signals a dovish rate rise, described as a move to 'reduce the risk of the continuing high energy prices' spreading broadly. The Canadian dollar saw little immediate reaction against the US dollar.

During his opening remarks, Governor Macklem stated:

Looking ahead, Governing Council 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.

Market odds for another rate increase this year had reached 32%, but the author now leans against that view. The Monetary Policy Report highlights the Bank of Canada's areas of concern.

The MPR points to increasing costs for chemicals, plastics, rubber products, semiconductors, and computer components among the product prices on the rise.

The Bank of Canada's previous move was a reduction to 2.25% in October 2025, concluding a series of cuts from a peak of 2025 in the aftermath of the post-pandemic inflation surge.

The rate decision was accompanied by revised quarterly projections. Earlier this month, Macklem cautioned that inflation forecasts would be 'quite a bit higher' compared to July's estimates.

Here are the new inflation forecasts:

• 2026: 2.9%, versus 2.5% in the previous forecast
• 2027: 3.1%, compared with 2.0% earlier
• 2028: 2.2%, up from 2.1%

GDP projections were also updated:

• 2026: 1.0%, versus 0.7% previously
• 2027: 2.0%, compared with 1.8%
• 2028: 2.0%, up from 1.8%

The 2027 CPI forecast is particularly problematic.

Countering the Bank of Canada's hawkish stance have been a number of unexpectedly weak economic data points, such as the two most recent employment reports. Meanwhile, consumer spending signals have stayed strong, and rising commodity prices provide a boost. Canada's housing market has faced difficulties for two years, with prices still declining across large parts of the nation.

The following excerpt from Macklem's statement reveals the internal debate within the Bank of Canada in straightforward language:

Against this backdrop, Governing Council considered two policy options: hold or hike.

The main argument for holding was that the rise in inflation has so far been concentrated in energy prices and in services that rely heavily on energy inputs, such as airfares. CPI inflation excluding gasoline is still 2.2%, and measures of core inflation remain close to 2%. In addition, while growth has been better than expected, economic slack remains, and new US tariffs will weigh on growth.

The main argument for an increase was that energy prices are higher, they are expected to remain higher, and cost pressures are building. As we’ve been saying for some time, the longer energy prices remain high, the more likely it is these costs will spill over to consumer prices more broadly.

The prices of gasoline, diesel and heating oil are considerably higher than in July and are expected to remain higher for longer. This is hitting consumers directly and raising business costs for production and transportation. Imported industrial and electronics input prices have also increased. While businesses have mostly absorbed higher input costs so far, past experience and Bank surveys suggest that cost pass-through will increase over the next year. The combination of higher energy prices and pass-through increases the persistence of inflation. In addition, with the economy expected to recover, there is less downward pressure on prices to offset these cost pressures.

Summing up, the path of interest rates depends on developments in the Iran conflict.