CA: Bank of Canada Announcement

Highlights

Caught between the U.S. trade war and the supply-shock-induced inflation due to the Iran war, the Bank of Canada decided to raise its policy rate for the first time in three years to 2.50 percent from 2.25 percent,"to reduce the risk that continuing high energy prices spread broadly to the prices of other goods and services."

The central bank left the door open for further rate hikes:"There could be a need to increase the policy rate further, but given uncertainties, Governing Council agreed to proceed carefully."

The deterioration in the inflation outlook combined with an improved growth outlook"despite continued trade actions by the United States" were two key developments that drove the central bank to act.

The other option would have been to keep the policy rate on hold, Governor Tiff Macklem said in his press conference opening statement."The main argument for holding was that the rise in inflation has so far been concentrated in energy prices and in services that rely heavily on energy inputs," he explained.

"The main argument for an increase was that energy prices are higher, they are expected to remain higher, and cost pressures are building," he said. Today's decision shows this was the winning argument and the governor added during a press conference that there was a clear consensus to hike. He said that inflation was"looking less likely" to be more contained and more likely to be higher. Still, Macklem insisted that the central bank will make decisions"one meeting at a time", adding"there is no predetermined path" for interest rates.

Asked whether a one-off interest rate hike could be effective, Senior Deputy Governor Carolyn Rogers said,"You should not interpret this decision as we've somehow decided that all of the uncertainty in the economy is gone and the economy isn't facing headwinds anymore". She reminded that many outcomes are possible, such as a resolution of the Middle East conflict, although"we don't think that looks to be imminent".

The tightening was expected by many analysts, although many questioned prior to the announcement whether it would be justified given that slack remains in the Canadian economy that just shed 110,000 jobs over two months, while core inflation is around target. In fact, in its argument to hold rates, the central bank acknowledged just that, noting that"CPI inflation excluding gasoline is still 2.2 percent, and measures of core inflation remain close to 2 percent. In addition, while growth has been better than expected, economic slack remains, and new U.S. tariffs will weigh on growth."

Today's hike brings the policy rate back to its September 2025 level. It also follows rate hikes by the ECB and the Federal Reserve in September.

“Inflation is higher and more persistent than in the July Report,” the central bank stressed, adding, “Growth has picked up this year and is expected to recover further”. The central bank's language around inflation signals concerns about cost pass-through from businesses to consumers:"While businesses have mostly absorbed higher input costs so far, Bank surveys suggest cost pass-through will increase over the next year."

The BoC projects a 2.0 percent annualized GDP growth in the third quarter after 3.3 percent in the second quarter, which is “stronger than expected”. At the same time, inflation is expected to average to 3.4 percent in the fourth of this year and 3.1 percent in 2027, more than a full percentage point above the 2.0 percent projected in July."The main sources of uncertainty around this forecast are developments in the Middle East and businesses’ responses to cost pressures," the BoC said.

Macklem had previously outlined the central bank's core dilemma regarding persistent inflation earlier this month on the sidelines of the International Monetary Fund (IMF) meetings in Bangkok: “The question we’re going to be asking ourselves is: Is inflation likely to come back down toward our target on its own, or are we going to have to raise interest rates to influence the path, nudge the path for inflation back toward the target?”

Meanwhile, the global context points to"resilient" economic activity, in particular with AI-related investment supporting growth in the U.S. As a result, the BoC revised up its growth outlook for the global economy as well, with a GDP growth now seen at 3.1 percent.

On the financial front, the central bank al pointed out tighter conditions compared to July, with higher sovereign bond yields in advanced economies,"volatile" equity and credit markets, while the Canadian dollar recovered after a period of U.S. dollar strength.

Market Consensus Before Announcement

BOC policy-makers have been sounding the alarm about the threat of inflation, which suggests a rate increase is coming but most forecasters think Canada’s economy is weak enough that the bank can wait a bit longer to move. That suggests no action this week but a rate hike is coming as soon as December.

Definition

Canada's central bank, the Bank of Canada (BoC), announces its monetary policy with regard to interest rates eight times a year. The announcement conveys to the financial markets and investors what, if any, changes in policy might be. The main focus is the target set for the overnight rate. Policy is framed around keeping the annual rate of inflation as measured by the consumer price index (CPI) within a 1 percent to 3 percent range and close to the 2 percent midpoint over the longer-run. To this end, the BoC also monitors an adjusted measure of the CPI that excludes a range of volatile categories in order to get a better handle on underlying trends.

Description

Bank of Canada determines interest rate policy at eight meetings during the year and they are an influential event for the markets. Prior to each meeting, market participants speculate about the possibility of an interest rate change. A post-meeting statement is issued after each meeting. Unlike the Federal Reserve, there are no post-meeting minutes. The Bank has an inflation target range of 1 percent to 3 percent with specific focus on the 2 percent midpoint.

Although the Bank monitors many economic indicators, as indeed all central banks do, the Bank converted its inflation barometer for operational purposes to a consumer price index measure that subtracts eight volatile components to better reflect core inflation. It also takes the foreign exchange rate for the Canadian dollar into its monetary policy decisions.

Monetary policy goals are to aid and abet solid economic growth along with rising living standards. To achieve these goals, inflation is kept low, stable, and predictable. The inflation control target is at the heart of Canadian monetary policy that the Bank and the Government have established. The level of interest rates and the exchange rate determine the monetary environment in which the Canadian economy operates.

The level of interest rates affects the economy. Higher interest rates tend to slow economic activity; lower interest rates stimulate economic activity. Either way, interest rates influence the sales environment. In the consumer sector, few homes or cars will be purchased when interest rates rise. Furthermore, interest rate costs are a significant factor for many businesses, particularly for companies with high debt loads or who have to finance high inventory levels. This interest cost has a direct impact on corporate profits. The bottom line is that higher interest rates are bearish for the financial markets, while lower interest rates are bullish.

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