Bank of Canada hikes rate to 2.5 percent

The Bank of Canada raised its benchmark interest rate to 2.5 percent on Wednesday. This marks the first increase in more than three years. Governor Tiff Macklem cited rising energy costs as the primary driver for the move. The bank aims to stop these high prices from becoming widespread price increases across the economy.

The central bank had held rates steady since July 2023. During that period, it focused on cooling the economy after previous hikes. Now, the bank has changed course. It expects inflation to remain elevated for longer than previously thought. The bank updated its forecast for 2027, predicting inflation will reach 3.1 percent. This is up from the 2 percent estimate provided in July.

Macklem stated that the economy shows resilience. He argued that higher rates are necessary to manage this strength against rising costs. He noted that the Governing Council saw increased risks to inflation. He added that there is less room for monetary support. The bank will proceed carefully but is open to further hikes if needed.

Current data supports the bank's concern. Annual inflation hit 3.2 percent in September. This figure is above the bank's target range of 1 to 3 percent. Energy and transportation costs drove most of this increase. Macklem expects annual inflation to end at 3.5 percent this year. He predicts it will stay near 3 percent for most of 2027. The rate should return close to 2 percent by mid-2028.

Market analysts view the current rate as a middle ground. Andrew Grantham, a senior economist at CIBC Capital Markets, said core inflation might not accelerate as much as the bank fears. He believes global energy prices may ease. Consequently, he does not expect the policy rate to rise above 2.75 percent. Money markets currently price in a 25 basis point cut in January. They also see the rate reaching 3.25 percent by December 2027.

Businesses are likely to raise prices to match their higher costs. Macklem warned this pass-through effect will make inflation more persistent. He pointed to ongoing uncertainties, including trade tensions with the United States and the Middle East conflict. He expects new US tariffs to slow the economy in the fourth quarter. However, he is confident growth will rebound in 2027.

The bank's new report projects economic growth for the third quarter at 2 percent. It expects growth to drop to 0.8 percent in the fourth quarter. This follows a strong 3.3 percent growth rate in the second quarter. The bank upgraded its GDP forecast for 2027 and 2028 to 2 percent. This is higher than the 1.8 percent predicted in July. The bank believes this extra growth will help absorb unused capacity in the economy.

Some economists opposed the hike. They argue that core inflation, which excludes volatile items, remains near 2 percent. They worry that higher rates could hinder a modest economic recovery. They also point to a weak job market and US trade tensions. The Bank of Canada will announce its next rate decision on December 9.