Bank of Canada raises policy rate as energy-driven inflation risks broaden

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Highlights

Bank of Canada raised its policy rate from 2.25% to 2.5% in October, citing broadening inflation risks from sustained high energy prices.
Policymakers revised the 2026 GDP growth outlook up to 1% and project 2% growth in both 2027 and 2028, despite ongoing economic slack.
CPI inflation is now expected to reach 3.5% by end-2026, stay above 3% through much of 2027, and return to 2% by mid-2028.

October decision and inflation rationale

As detailed by the Bank of Canada, policymakers spent much of their October deliberations assessing whether prolonged high energy prices were beginning to create broader and more persistent inflation pressures across the Canadian economy.

Members said the global backdrop had strengthened since the July Monetary Policy Report, even as inflation remained elevated in many economies. In the United States, solid consumer spending and investment tied to artificial intelligence were expected to support growth, while higher oil prices and supply-chain cost pressures were seen keeping inflation high through 2026. The conflict in the Middle East continued to restrict oil supply, leaving benchmark crude prices about U.S.$35 per barrel above the level assumed in July.

In Canada, the council said economic growth in the middle of the year was stronger than expected. GDP grew 3.3% in the second quarter, and indicators pointed to growth of about 2% in the third quarter, although escalating trade tensions with the United States late in the summer were expected to weigh on fourth-quarter activity. Consumer spending remained solid, exports were supported by robust U.S. demand and added pipeline capacity, and business investment was expected to accelerate over the next two years, helped by AI-related spending, stronger oil and gas investment and government incentives.

Members said headline inflation had been running around 3% since April, largely because of energy-linked components such as gasoline and travel services, while core inflation measures remained near 2%. Still, they concluded that persistent fuel and import cost increases were likely to pass through more broadly to consumer prices over time, citing both historical experience and Bank surveys showing businesses expected to pass on a greater share of higher costs during the next year.

Against that backdrop, Governing Council debated whether to keep the policy rate at 2.25% or raise it to 2.5%. The case for holding rested on still-contained core inflation, remaining economic slack and the risk that new U.S. tariffs would weaken growth. The case for raising rates centered on the risk that higher prices for gasoline, diesel and heating oil, combined with future business pass-through, could entrench broader inflation. Members ultimately chose to raise the policy rate to 2.5%.

Growth outlook and policy path

The council revised up its growth outlook for 2026 to 1% and expects the economy to expand by 2% in both 2027 and 2028. Members agreed that some slack remains in the economy, but they also said firmer growth would gradually absorb excess supply and reduce the offset to mounting cost pressures.

Residential investment is expected to stay relatively weak because slow population growth, affordability constraints, higher mortgage rates and elevated uncertainty continue to weigh on housing activity. Labour market conditions were described as broadly moving sideways since the start of the year, with subdued overall employment growth and unemployment holding around 6.5%, though some members said private-sector job creation points to more underlying strength than headline figures suggest.

The inflation outlook was raised substantially from July. Policymakers expect CPI inflation to reach 3.5% at the end of 2026, remain above 3% through much of 2027 and then gradually return to the 2% target by the middle of 2028. Members said near-term inflation expectations had moved higher, although longer-term expectations remained anchored.

Looking ahead, the council said further rate increases could still be needed, but stressed that decisions will be taken one meeting at a time. Members said uncertainty remains high around the war in the Middle East, Canada-U.S. trade relations, global financial conditions and the speed at which higher business costs feed through to consumer prices.

We have previously detailed UBS Fed outlook that projected additional rate hikes into 2027 on persistent inflation pressures.

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