Bank of Canada raises key interest rate to 2.5%, its first hike since 2023

The bank lifted the rate by 25 basis points to 2.5 per cent, as widely expected, and also ramped up its inflation forecast for 2027 to 3.1 per cent from the 2.0 per cent it had predicted in July. Growth this year is set to be 1.0 per cent, higher than the 0.7 per cent seen in July.

“With the outlook for inflation substantially higher and the economy showing resilience, an increase in the policy rate is needed to reduce the risk that elevated energy prices could spill over and become generalized inflation,” Governor Tiff Macklem said in opening remarks to reporters.

“There could be a need to increase the policy rate further, but given uncertainties, we will proceed carefully.”

The annual inflation rate hit 3.2 per cent in September, above the bank’s one-three per cent target range, almost solely led by higher energy and energy-related costs of transportation.

Macklem said inflation was expected to end the year at 3.5 per cent and stay around three per cent for most of next year before returning close to the two per cent target by the middle of 2028.

“Governing Council agreed that risks to inflation had increased and there was less scope for monetary accommodation,” Macklem said.

The rate hike was the first since July 2023 and first move in a year.

Despite the increase, the rate is still below the neutral rate, a monetary policy level which is neither considered restrictive or accommodative.

Past experience and the BoC’s surveys suggest that cost pass-through will increase over the next year, increasing overall inflation, Macklem said.

“The combination of higher energy prices and pass-through increases the persistence of inflation,” he said, although he added that there are lingering uncertainties such as the trade rift with the United States and a faster resolution of the conflict in Middle East.

Economists who opposed a hike said core inflation, which strips out the cost of volatile items, is still hovering around two per cent. They also say a rate hike could impede modest economic recovery, given U.S. trade tensions and a weak job market.

Macklem said new U.S. tariffs would slow the economy in the fourth quarter, but expressed confidence that growth should pick up again in 2027 as consumer spending continues, exports pick up and business investment strengthens.

After a robust annualized growth of 3.3 per cent in the second quarter, the economy is likely to slow to two per cent in the third quarter and further down to 0.8 per cent in Q4, the BoC’s new monetary policy report projected.

The report, however, upgraded its GDP forecast for next year and year after to two per cent from 1.8 per cent for both 2027 and 2028 as predicted in July.

Macklem said this additional growth would help absorb the slack, or its unused capacity, in the economy.