In a widely expected move, the Bank of Canada raised its key lending rate, which directly impacts interest rates, by 25 basis points, to 2.50%. This marks the first change in its interest rate policy in a year and the first increase since July 2023.
The war in Iran and other geopolitical tensions, which have pushed energy prices significantly higher since the start of the year, have resulted in higher oil and gas prices. Uncertainty with Canada’s ongoing trade war has also created economic headwinds. Energy and trade with the U.S. are the two biggest economic issues related to the cost of living. This has resulted in higher inflation.
The Bank of Canada’s goal is to keep inflation near 2%. In September, Canada’s headline inflation increased to 3.1%. Prices jumped in areas that hit Canadians the hardest. Gasoline prices jumped 27.8% on an annual basis (after advancing 22.8% in August). Grocery prices were also up 1.7%. Over the last six years, grocery prices have increased 33%.
To combat rising inflation and keep prices in check, the Bank of Canada needs to raise interest rates. This makes it more expensive to borrow, which, in theory, should help the economy slow down.
Tiff Macklem, the governor of the Bank of Canada, said the interest rate hike is “not going to feel good,” but “that’s how you get inflation back down, and that will feel good for Canadians and Canadian businesses.”
It will take some time, though, for interest rates to impact inflation. The Bank of Canada noted that it expects inflation to rise to 3.5% by the end of 2026.
Could the Bank of Canada Raise Interest Rates Again?
The outlook for the Canadian economy remains muted, with gross domestic product (GDP) projected to grow by 1% in 2026 and 2% in 2027 and 2028. Those forecasts could change, though, due to uncertainty about tensions in the Middle East and trade tensions between Canada and the U.S.
As a result, additional interest rate increases are on the table. Bay Street economists think the Bank of Canada will proceed with caution, but they still expect the central bank to increase interest rates by 25 basis points to 2.75% when it meets next in January.
What will the Bank of Canada do after that? Inflation may be stubbornly high, but the Canadian economy is facing major headwinds. As a result, there is only so much the Canadian economy can absorb when it comes to further interest rate hikes in 2027.
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