Bank of Canada Lifts Rate to 2.50% as Inflation Outlook Deteriorates, More Tightening on the Table

The Bank of Canada raised its overnight policy rate by 25 basis points from 2.25% to 2.50%, broadly aligning with market expectations. The move comes as stronger-than-anticipated economic growth and a more persistent inflation outlook warranted further monetary restraint. The Bank noted that growth has picked up since the July Monetary Policy Report, while elevated energy prices are increasingly threatening to spread into broader consumer prices. Governing Council left the door open to additional tightening, stating that “there could be a need to increase the policy rate further,” but emphasized that heightened uncertainty required a careful approach to subsequent decisions.

The most significant change came in the inflation projections. CPI inflation has remained around 3% since April and is now expected to rise to approximately 3.5% by the end of 2026, before averaging 3% in 2027, around one percentage point above the July forecast. Inflation is projected to remain above 3% through much of next year, with a return toward the 2% target delayed until mid-2028. The upward revision reflects persistently high oil prices, elevated refinery margins, and higher imported input costs. The Bank also expects inflationary pressures to become more persistent as the effects of these increases spread gradually through production and supply chains.

Importantly, underlying inflation has not yet shown the same degree of deterioration as the headline outlook. CPI excluding gasoline stood at 2.2% in September, while core inflation measures remained close to 2%. Businesses have largely absorbed higher fuel, transportation, and imported input costs so far, but Bank surveys indicate that firms expect to pass on a greater share over the next year. This anticipated increase in cost pass-through is central to the Bank’s concern that prolonged energy pressures could become embedded in a broader range of goods and services prices. The Bank nevertheless expects labour costs adjusted for productivity to remain contained, suggesting that the projected inflation persistence is driven primarily by energy and imported costs rather than an emerging wage-price spiral.

Meanwhile, Canada’s growth outlook has strengthened, with GDP expanding 3.3% in Q2 and estimated to grow around 2% in Q3, both stronger than previously anticipated. The Bank revised its 2026 growth forecast upward to 1.0% and expects expansion of 2.0% in both 2027 and 2028, supported by business investment, exports, and government spending. However, new US tariffs are expected to slow activity in Q4, while unemployment near 6.5% and remaining excess supply indicate that the economy is not broadly overheating. The combination of stronger growth and more persistent cost-driven inflation supports the possibility of further tightening, but does not guarantee another hike at the December 9 meeting. The Bank’s next move will depend on whether higher costs continue spreading into consumer prices and how the economy responds to trade uncertainty and previous rate increases.

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