OTTAWA
The Bank of Canada raised its policy interest rate by 25 basis points to 2.5 per cent on Wednesday, its first hike since July 2023.
Governor Tiff Macklem said the increase was needed to reduce the risk that raised energy prices could spill over and become generalized inflation.
"With the outlook for inflation substantially higher and the economy showing resilience, an increase in the policy rate is needed," Macklem said in prepared remarks.
The central bank now projects inflation will remain above three per cent throughout the rest of 2026 and much of 2027, according to its October Monetary Policy Report.
It revised its projected average inflation rate upward to 2.9 per cent for 2026 and 3.1 per cent in 2027. The annual inflation rate hit 3.2 per cent in September, above the bank's target range.
Macklem said the outlook for inflation has "deteriorated" since the bank's July report, with the persistent war in the Middle East keeping global oil prices higher for longer.
The price of Brent crude is averaging $124.96 per barrel in October, about $35 more than in July.
Of the consumer-facing businesses surveyed by the central bank, 60 per cent expect to pass costs on to customers in the next 12 months.
The bank said the rise in energy prices and uncertainty surrounding Canada's trade relationship with the United States are the two biggest risks to increasing costs of living.
Macklem warned that the fourth quarter will likely show slower growth as "new US tariffs weigh on activity."
Despite that, the bank upgraded its economic growth forecast. Real GDP growth is now expected to be around one per cent in 2026, before strengthening to two per cent in 2027 and 2028.
Growth reached 3.3 per cent in the second quarter but is expected to slow to 2 per cent in the third quarter.
Macklem said growth can be attributed to "solid consumer spending" and a rebound in business investment, primarily led by activity in the oil and gas sector.
The bank's monetary report also pointed out the unemployment rate has hovered around 6.5 per cent in recent months, which suggests that it is "more difficult than usual for the unemployed to find work."
Macklem said there was less scope for monetary accommodation with increasing inflation risks.
"There could be a need to raise the policy rate further, but given the uncertainties we will proceed carefully," he said.
Taylor Schleich, director of economics and strategy at the National Bank of Canada, said the inflation outlook was "jarring."
"The Bank of Canada is not projecting price stability," he said, noting the much longer horizon for three per cent inflation.
Schleich now expects another 25-basis point hike to 2.75 per cent in December.
Shelly Kaushik, a senior economist at BMO Capital Markets, said the central bank was sharply focused on inflation instead of the growth outlook.
She expects another 25-basis point hike in January.
"It's hard to argue for just one rate hike unless things meaningfully change from here," Kaushik said.
Andrew Grantham, senior economist at CIBC Capital Markets, said he does not think the policy rate will need to move above 2.75 per cent.
Money markets are pricing in another 25 basis point rate hike in January and see the benchmark rate going up to 3.25 per cent by December next year.
The Bank of Canada's next rate decision is on December 9.
e2gold.ca reported earlier this week that the rate hike adds to a subdued outlook for the housing market.
This story was written by the e2gold.ca newsroom from reporting by BNN Bloomberg, CTV News, Financial Post and Al Jazeera. Quotes are checked word for word against that reporting.