Bank of Canada Raises Rate to 2.5% on Energy Costs, First Hike Since 2023

The Bank of Canada raised its benchmark rate by 25 basis points on Wednesday to 2.5 percent, marking its first increase since July 2023. The move, widely expected by markets, came alongside a revised inflation projection of 3.1 percent for 2027, up from the 2 percent forecast in July. The bank's growth estimate for this year also rose, to 1 percent from 0.7 percent.

Governor Tiff Macklem said the combination of a stronger inflation outlook and a resilient economy required action to prevent elevated energy costs from turning into "generalised inflation." He said the Governing Council agreed that risks to inflation had grown and that there was less room for monetary accommodation. Macklem added that additional tightening could follow, though the bank "will proceed carefully" given the uncertainties, including the trade dispute with the United States and the possibility of a faster resolution to the conflict in the Middle East.

Annual inflation hit 3.2 percent in September, above the bank's 1 to 3 percent target range, driven almost entirely by energy and energy-related transportation costs. Macklem projected inflation will close the year at 3.5 percent, stay near 3 percent through most of 2027, and return close to the 2 percent target by the middle of 2028. He cited past experience showing that businesses pass higher costs through their own pricing over the following year, which can make inflation more persistent.

Not all economists supported the decision. Those opposed noted that core inflation, which excludes volatile items, remains around 2 percent, and argued that higher borrowing costs could weigh on a modest recovery already facing US trade tensions and a weak job market. Andrew Grantham, senior economist at CIBC Capital Markets, said he does not expect core inflation to accelerate as much as the bank projects, particularly if global energy prices ease. He does not expect the policy rate to exceed 2.75 percent, while money markets price in a benchmark rate of 3.25 percent by December next year.

The bank's monetary policy report projects annualized growth slowing from 3.3 percent in the second quarter to 2 percent in the third and 0.8 percent in the fourth, with new US tariffs weighing on activity in the final quarter. Macklem said growth should recover in 2027 as consumer spending continues, exports rise and business investment strengthens. GDP forecasts for 2027 and 2028 were raised to 2 percent from the 1.8 percent projected in July. The next rate decision is scheduled for December 9.

Macklem said inflation is expected to finish 2026 at 3.5 percent, hover near 3 percent for most of 2027, then ease toward the 2 percent target by mid-2028. He attributed September's 3.2 percent reading largely to energy and energy-related transportation costs, which pushed the figure above the bank's 1 to 3 percent target range.