{"id":16198,"date":"2026-10-22T16:08:34","date_gmt":"2026-10-22T16:08:34","guid":{"rendered":"https:\/\/www.rbc.com\/en\/economics\/?p=16198"},"modified":"2026-10-22T16:25:59","modified_gmt":"2026-10-22T16:25:59","slug":"the-bank-of-canada-at-an-inflection-point-inflation-fears-live-on","status":"publish","type":"post","link":"https:\/\/www.rbc.com\/en\/economics\/forward-guidance\/the-bank-of-canada-at-an-inflection-point-inflation-fears-live-on\/","title":{"rendered":"The Bank of Canada at an inflection point: Inflation fears live on"},"content":{"rendered":"\n
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For the week of October 26th<\/sup><\/strong><\/p>\n\n\n\n

We are now pencilling in the Bank of Canada\u2019s first interest rate hike of 25 basis points since March 2022 on Wednesday as it faces a pivotal decision amid evolving economic conditions.<\/p>\n\n\n\n

But, we have very low conviction on the idea of a rate hike this soon, and it\u2019s almost equally probable the central bank uses this meeting to tee-up a coming hike in December or January.<\/p>\n\n\n\n

Importantly, our expectation of a move higher from the BoC on Wednesday is not because we believe there is an urgency to hike interest rates.<\/p>\n\n\n\n

Instead, it\u2019s driven by our interpretation of policymakers\u2019 communication since Sept. 2nd<\/sup>, which has consistently emphasized a laser focus on safeguarding against future inflation risks from higher energy prices, and uncomfortable waiting for another inflation rise to materialize.<\/p>\n\n\n\n

The case for patience is strong<\/h4>\n\n\n\n

In our view, the case for the central bank continuing to wait on the sidelines remains compelling.<\/p>\n\n\n\n

The Canadian economy is improving, but still not strong. There is sufficient slack, in our view, that will slow inflation passthrough . Job growth has disappointed, and there is no evidence that elevated energy prices are bleeding into broader core inflation measures. Housing markets remain weak, and August gross domestic product data released next Friday should confirm that growth slowed in Q3 after surging in Q2.<\/p>\n\n\n\n

Trade disruptions following the breakdown of Canada-United States\u2019 trade talks, and imposition of new tariffs late August add another layer of complexity even as the Bank has downplayed this factor of late.

Meanwhile, the term structure of government bond yields has already done some of the central bank’s work. Five-year government bond yields have risen more than 40 basis points over the last three months, reflecting market expectations of rate increases.<\/p>\n\n\n\n

And much of the borrowing by Canadian households and businesses are done at fixed rates, and interest rates for new loans have already been rising.<\/p>\n\n\n\n

But the BoC\u2019s risk calculus appears to have changed<\/h4>\n\n\n\n

Yet, communication ranging from the Sept. 2nd<\/sup> rate decision to Governor Tiff Macklem’s comments recently on the sidelines of the International Monetary Fund meetings repeatedly conveyed\u2014whether intentionally or not\u2014that the BoC no longer believes it can wait passively for inflation to materialize before acting.<\/p>\n\n\n\n

This shift seems  to reflect a recalibration of the central bank’s risk calculus. In particular, it suggests less of a focus on the here and now, but instead attention most on what lies ahead. To be fair, that forward outlook is, indeed, improving. The economy is expected to gradually improve, business optimism remains resilient despite recent trade disruptions with the U.S., and the central bank’s overnight rate\u2014currently at the lower end of the neutral range\u2014leaves room for measured increases without triggering economic distress.<\/p>\n\n\n\n

In part, our growth forecasts for 2027 was a factor in our prior base case projection of rate hikes beginning in Q1.<\/p>\n\n\n\n

Ghost of post-pandemic inflation surge<\/h4>\n\n\n\n

What\u2019s also likely weighing on the central bank are the cautionary lessons of the post-pandemic inflation surge of 2022-23 that demonstrated how supply-side shocks and persistent cost pressures can overwhelm an economy surprisingly quickly.<\/p>\n\n\n\n

There may indeed be value in some insurance against a repeat of that episode. While conditions today differ in many respects to 2022, West Texas Intermediate oil prices have averaged $95 a barrel since the last rate decision\u201454% higher than the same period last year. As long as they stay there, cost pressures will continue building throughout the economy as Canadians continue to absorb what was, for many of them, the largest inflation shock of their lives just a few years earlier.<\/p>\n\n\n\n

The BoC will be using a new forecasting tool (PRIMA) in October, designed in large to better account for supply side shocks to inflation.<\/p>\n\n\n\n

A hike now doesn\u2019t change our outlook for Canada<\/h4>\n\n\n\n

While we don\u2019t see an immediate need for the BoC to hike now, at the same time, a 25-basis-point increase in the overnight rate on Wednesday won\u2019t materially change our medium-term economic outlook compared to a December or January hike.<\/p>\n\n\n\n

Although it slightly increases the odds of a growth slowdown in Q4, particularly in heavily interest rate sensitive sectors like housing, our base case forecast already assumed 100 basis points of increases in 2027, contingent on a gradually improving economy.<\/p>\n\n\n\n

Shifting the timing of the first of those hikes does not significantly impact the growth outlook. So, rather than the rate hike itself, we will be monitoring for any communication that helps us understand the Bank of Canada\u2019s expected path of interest rates ahead \u2013 how many more hikes and when.<\/p>\n\n\n\n

Ultimately, the signal of a rate hike on October 28thhas a larger meaning we shouldn\u2019t ignore: Central banks do not have the same patience for inflation they might have had in the past, and are willing to act preemptively to guard against it.<\/p>\n\n\n\n

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