Insights

The Bank of Canada raised its overnight rate by 25 bps to 2.5%, its first increase since 2023.

The decision in the end was well-telegraphed by multiple communications in the past 2 months that suggested the central bank was leaning towards a rate increase in response to higher energy prices and the concern they would bleed more broadly through to consumer inflation

Importantly, however, in its rate decision today, the BoC put additional emphasis on a firmer-looking current economic growth and expected future improvement in the outlook (despite international trade uncertainty).  Thus, the rate hike isn’t all about energy prices —  the BoC seems increasingly sensitive to both the supply- and demand-side factors that could lift inflation in 2027.  

As we’ve said before, in our view, there was no urgency to hike rates at this meeting based on the current state of growth or inflation. The BoC indeed acknowledged in its Monetary Policy Report that there is slack in the labour market and that core measures of inflation have remained near 2%. Yet, the concerns around future inflation, coupled with a stronger economic growth outlook conveyed that today’s rate decision was essentially a risk management hike – the risks of future inflation were judged to have increased more than downside economic growth risk. Effectively, today’s rate hike was preventative treatment.

What’s next? With significant risks and uncertainties still in play, the BoC was explicitly noncommittal about the potential for future increases (“there could be a need to increase the policy rate further, but given uncertainties, Governing Council agreed to proceed carefully”) signaling that further increases will remain dependent on the evolution of economic growth and inflation data. But while the exact timing and magnitude of interest rate moves maintains some level of uncertainty, the direction is clear: Canada will likely see higher rates in the year ahead.

Two key takeaways from today’s decision:

1. What happens next will still depend on the evolution of growth and inflation data

Our own base case forecast ahead of today’s decision presumed that gradual improvements in the economy would meet the bar for 100bps total of rate hikes (3 more after today). We continue to expect this is a reasonable starting assumption.  In particular, we strongly suspect that today’s rate hike will come coupled with another hike at one of the next two meetings (December or January).

One more hike would bring rates to the mid-point of the central bank’s estimated neutral range for the overnight rate. Effectively, it would mean rates were neither easing or tightening – neutral ground from which to decide how much more will be needed.

At that point, future decisions, will likely be guided by incoming data: growth needs to continue to improve, the labor market needs to heal, and there should be some evidence that higher input costs for companies have passed through to consumer prices

Importantly, we took note that the central bank’s revised economic projections lightly exceed even our rosy take on growth. The BoC revised  GDP growth up to 2.0% for 2027, above our own 1.6% forecast, with a relatively cheerful take on business investment improving. We thus see more risk of growth data surprising to the downside relative to the Bank’s projections in 2027, which would provide more breathing room to assess how inflation is progressing.  

2. Our outlook for the economy is still unchanged

There’s no doubt that some Canadians will feel the impact of higher short-run interest rates, and highly interest rate sensitive sectors like housing could be impacted more in the coming months. 

However, in aggregate, the economy isn’t likely to be knocked off course by this or a few more rate hikes. That’s in part because expected interest rate hikes had already been priced into the term government bond yields that are a more important driver of consumer and business fixed rate borrowing costs. Secondly, at these “neutral” levels, rates should not add to or subtract from broader growth or inflation over time. Lastly, Canada’s economy has proved resilient in the past year and fiscal (government spending and tax) policy is also ramping up as a policy support, reducing the need for additional monetary policy support.  

We continue to expect the economic growth backdrop will be able to absorb some modest move higher in rates.

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About the author:

Frances Donald is the Chief Economist at RBC and oversees a team of leading professionals, who deliver economic analyses and insights to inform RBC clients around the globe. Frances is a key expert on economic issues and is highly sought after by clients, government leaders, policy makers, and media in the U.S. and Canada.

Nathan Janzen is an Assistant Chief Economist, leading the macroeconomic analysis group. His focus is on analysis and forecasting macroeconomic developments in Canada and the United States.

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