Bank of Canada Lifts Rates for First Time in Over Three Years as Energy Costs Bite

The Bank of Canada raised its benchmark interest rate on Wednesday, its first increase in more than three years, and cautioned that further hikes could be necessary if higher energy costs begin to push up prices across the wider economy.

The quarter-point move, which lifts the rate to 2.5 percent, was widely anticipated. It is the first increase since July 2023. The bank also sharply revised its inflation outlook, now projecting 3.1 percent for 2027, up from the 2 percent it forecast in July. Its growth estimate for this year rose to 1 percent from 0.7 percent.

Governor Tiff Macklem said the stronger inflation outlook and a resilient economy made a hike necessary to limit the risk that elevated energy prices turn into "generalised inflation." He added that more tightening may be needed but that, given the uncertainties, the bank "will proceed carefully."

Annual inflation reached 3.2 percent in September, above the bank's target range of 1 to 3 percent. The increase came almost entirely from higher energy and energy-related transportation costs. Macklem said inflation is expected to finish the year at 3.5 percent and hover near 3 percent for most of 2027, before easing back close to the 2 percent target by the middle of 2028.

He pointed to past experience suggesting that businesses pass higher costs on through their own prices over the following year, which makes inflation more persistent. Macklem said the Governing Council agreed that risks to inflation had grown and that there was less room for monetary accommodation. He also noted lingering uncertainties, including the trade dispute with the United States and the possibility of a faster resolution to the conflict in the Middle East.

Not all economists backed a hike. Those who opposed it noted that core inflation, which excludes volatile items, remains around 2 percent. They argued that higher borrowing costs could undermine 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 fears, particularly if global energy prices ease somewhat. He does not think the policy rate will need to rise above 2.75 percent. Money markets, by contrast, see the benchmark rate climbing to 3.25 percent by December next year.

On the economy, the bank's new monetary policy report projects growth slowing from a robust annualised 3.3 percent in the second quarter to 2 percent in the third and 0.8 percent in the fourth. Macklem said new US tariffs will weigh on activity in the fourth quarter, but he expressed confidence that growth will recover in 2027 as consumer spending continues, exports rise and business investment strengthens.

The report raised the GDP forecast for both 2027 and 2028 to 2 percent, from the 1.8 percent projected in July. Macklem said the extra growth would help absorb slack, meaning unused capacity in the economy. The bank's next rate decision is scheduled for December 9.