The Bank of Canada (BoC) has raised its key interest rate for the first time in more than three years and warned that further increases might be needed to prevent soaring energy costs from fueling broader inflation. Wednesday’s quarter-point hike to 2.5 percent was widely expected, while the bank also ramped up its inflation forecast for 2027 to 3.1 percent from the 2 percent it had predicted in July. Growth this year is set to be 1 percent, higher than the 0.7 percent seen in July.
The annual inflation rate hit 3.2 percent in September, above the bank’s 1 to 3 percent target range, and was driven almost solely by higher energy and energy-related transportation costs. Macklem said inflation was expected to end the year at 3.5 percent and stay at around 3 percent for most of 2027, before returning close to the 2 percent target by the middle of 2028. The rate hike was the first since July 2023.
Money markets are pricing in another 25 basis point rate cut in January and see the benchmark rate going up to 3.25 percent by December next year. Past experience suggests that businesses will increase the cost of products and services in line with changing costs over the next year, increasing overall inflation, Macklem said. Economists who opposed a rise said core inflation, which strips out the cost of volatile items, is still hovering at about 2 percent.
They also say a rate hike could impede modest economic recovery, given US trade tensions and a weak job market. Macklem said new US tariffs would slow the economy in the fourth quarter, but expressed confidence that growth should pick up again in 2027 as consumer spending continues, exports pick up and business investment strengthens. After a robust annualised growth of 3.3 percent in the second quarter, the economy is likely to slow to 2 percent in the third quarter and further down to 0.8 percent in the fourth quarter, the BoC’s new monetary policy report projected.
The report, however, upgraded its gross domestic product (GDP) forecast for next year and the year after to 2 percent from 1.8 percent for both 2027 and 2028, as predicted in July. Macklem said this additional growth would help absorb the slack, or its unused capacity, in the economy. The BoC’s next rate decision is on December 9.
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