Bank of Canada Hikes Rates to 2.5 Percent

The Bank of Canada raised its key interest rate by 25 basis points to 2.5 percent on Wednesday. This marks the first increase in monetary policy since July 2023. Governor Tiff Macklem stated that the move was necessary to reduce the risk that high energy prices would spread into general inflation.

The central bank had held rates steady for over three years before this decision. In July, the bank projected 2 percent inflation for 2027. The new monetary policy report increases that forecast to 3.1 percent. The bank also revised its estimate for 2026 economic growth upward to 1 percent, compared to the 0.7 percent projected in July.

Annual inflation reached 3.2 percent in September. This figure sits above the bank's 1 to 3 percent target range. Macklem attributed the rise almost entirely to higher energy and related transportation costs. He noted that governing council members agreed the risks to inflation had increased and that there was less room for monetary accommodation.

Macklem predicted inflation would end 2026 at 3.5 percent. He expects rates to remain near 3 percent for most of 2027 before falling close to the 2 percent target by mid-2028. The bank warned that further rate increases might be required if energy costs persist, though it plans to proceed carefully given existing uncertainties.

Economic forecasts show the gross domestic product will slow to 2 percent in the third quarter and 0.8 percent in the fourth. This follows 3.3 percent growth in the second quarter. The bank raised its GDP forecasts for 2027 and 2028 to 2 percent, up from 1.8 percent in its previous report. Macklem said this additional growth will help absorb unused capacity in the economy.

New US tariffs are expected to slow growth in the fourth quarter. However, Macklem expressed confidence that the economy will recover in 2027 as consumer spending, exports, and business investment strengthen. He cited trade tensions with the United States and the conflict in the Middle East as lingering uncertainties.

Economist Andrew Grantham of CIBC Capital Markets countered that core inflation remains near 2 percent. He argued the policy rate does not need to rise above 2.75 percent if global energy prices ease. Money markets currently price in another 25 basis point increase, with the benchmark rate potentially reaching 3.25 percent by December 2027. The Bank of Canada will announce its next rate decision on December 9.