Bank of Canada Governor Tiff Macklem spoke at an IMF event in Thailand over the weekend. His hawkish tone has shifted market predictions towards a hike at next week's interest-rate decision.Patipat Janthong/Reuters
Financial markets have begun betting on a rate hike from the Bank of Canada next week, putting more weight on hawkish remarks by Governor Tiff Macklem than better-than-expected September inflation data.
On Monday, Statistics Canada reported that the annual rate of inflation ticked up to 3.1 per cent in September from 3 per cent the month before, driven by a 6.1-per-cent monthly increase in gasoline prices.
The headline number was actually better than Bay Street forecasters expected, and there were few signs that the energy price shock was spreading to other consumer prices.
But that seemed to provide cold comfort to bond traders, who were paying closer attention to comments that Mr. Macklem made over the weekend suggesting that high oil prices are becoming a major concern for the Bank of Canada.
This hawkish view was reinforced on Monday by a pair of central-bank surveys showing an uptick in inflation expectations, particularly among Canadian consumers.
Markets and some economists pivot to believing the BoC will hike rates next week
By Monday afternoon, interest rate swap markets, which capture market expectations for monetary policy, were pricing in around an 80-per-cent chance that the bank would raise its benchmark interest rate by a quarter-point at its Oct. 28 rate decision, according to Bloomberg data. That’s up from roughly 35 per cent on Friday.
Several Bay Street forecasters also changed their Oct. 28 calls from hold to hike – although this remains a minority view among analysts.
“Central bankers can no longer look through the inflationary impact of high energy prices,” Royce Mendes, head of macro strategy at Desjardins, wrote in a note to clients on Monday. “Businesses have faced elevated input costs for long enough that we now believe more broad-based consumer price increases are imminent.”
“The fact that core inflation has remained around the 2-per-cent target is comforting, but it shouldn’t stop the forward-looking central bank from tightening policy in the near term,” he added.
The Bank of Canada has held its policy rate steady at 2.25 per cent for the past year, weighing upside risks to inflation stemming from the war in the Middle East and the resulting oil price spike against downside risks to Canada’s economic growth tied to the trade war with the United States.
For months, Mr. Macklem and his team were inclined to look past high oil prices, on the assumption that changes to interest rates can’t do much to control a supply-side price shock. However, the longer energy prices have remained high, the more worried Canada’s central bankers have become that this will push up other prices across the economy and that inflation expectations will become unanchored.
Speaking to reporters on Saturday morning after the annual meeting of the International Monetary Fund in Bangkok, Mr. Macklem said that he expected the bank to revise its inflation forecast up later this month, given that oil prices are much higher than the bank previously expected, with few signs that the war in the Middle East will end any time soon.
“If oil prices stay around US$100, we expect inflation to gradually drift up from where it is today: 3 per cent,” Mr. Macklem said.
“The question we’re going to be asking ourselves is: Is inflation likely to come back down toward our [2-per-cent] 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.”
Other central banks, including the U.S. Federal Reserve and the European Central Bank, began raising interest rates last month in response to high energy prices.
Based on the September inflation numbers, there’s little evidence that the oil price shock is becoming a broad-based inflation problem in Canada – at least so far.
Excluding energy, the rate of inflation eased to 2.2 per cent from 2.4 per cent the month before, while the Bank of Canada’s two preferred measures of underlying inflation each fell by a notch to 1.9 per cent and 1.8 per cent.
Meanwhile, annual grocery price inflation declined to 1.7 per cent from 2.8 per cent in August, thanks to a combination of falling vegetable and confectionary prices, and slower price increases for products like beef. That was the smallest year-over-year grocery price jump since May, 2024, Statscan said.
While data suggest inflation remains relatively contained, the Bank of Canada makes decisions based on where it thinks inflation will go in the future; here, consumer and business inflation expectations play a role.
The bank’s quarterly consumer survey, published Monday, showed a sharp uptick in long-term inflation expectations, with individuals telling the bank that they’re worried about the inflationary impacts of both tariffs and high gasoline prices.
A separate survey of businesses found a slightly more complicated picture. The survey was conducted both before and after the trade talks between Ottawa and Washington broke down in late August.
Businesses surveyed before the talks collapsed had an improved sales outlook and slightly lower expectations for inflation than in previous quarters. But companies surveyed after Prime Minister Mark Carney walked away from the negotiating table expected weaker sales and higher inflation.
“Roughly half of firms, more than in the previous quarter, said they plan to pass on to customers some or all of their cost increases related to the war in the Middle East and tariffs,” the Bank of Canada said in the survey publication. “After already passing through some earlier cost increases, firms, especially consumer‑facing ones, plan to continue passing on past increases to customers over the next 12 months.”
The central bank remains in a tough spot. The past two Canadian jobs reports have been notably weak, and the threat of additional U.S. tariffs could weigh on economic activity going forward. This weakness is an argument for the central bank to remain on hold, at least in the near term.
“We continue to see fragile economic recovery as the biggest counterweight to heightened inflation risks, and expect caution from the BoC, especially when rising bond yields are already tightening financial conditions and raising borrowing costs for businesses and households,” Claire Fan, senior economist at Royal Bank of Canada, wrote in a note to clients.
But, she said, “risks to our base-case forecast of no rate hikes until 2027 are tilted toward earlier moves – including potentially as early as next week’s decision.”
After a year on the sidelines, the central bank is broadly expected to start a modest hiking cycle sometime in the coming months. The main question is when things will kick off – and next week is now being viewed as a live decision.