Bank of Canada raises interest rate as inflation outlook worsens

OTTAWA — The Bank of Canada raised its policy interest rate by 25 basis points to 2.5 per cent, its first increase since July 2023. The central bank says the move is intended to control inflation by reducing the risk that high fuel prices spread through the broader economy. In its October Monetary Policy Report, it identified rising energy prices and uncertainty around Canada’s trade relationship with the United States as the two biggest risks to higher living costs.

The bank said high energy costs have not yet spread broadly to other prices, but cost pressures are building and businesses expect to pass more of their increased costs on to customers. Inflation is currently 3.1 per cent. Governor Tiff Macklem said the inflation outlook had “deteriorated” since the bank’s July report. In prepared remarks at a Wednesday morning news conference, he said an increase was needed because the inflation outlook was substantially higher and the economy was showing resilience, to reduce the risk that elevated energy prices would spill over into generalized inflation.

Macklem said the continuing war in the Middle East means global oil prices will stay higher for longer, continuing to affect Canadians at the gas pump and raising costs for many businesses. Eight months after the United States and Israel launched a war against Iran, Brent crude averaged $124.96 per barrel in October, about $35 more per barrel than in July. Among the consumer-facing businesses surveyed by the bank, 60 per cent expect to pass costs on to customers in the next 12 months.

A stronger-than-expected Canadian economy is also contributing to the worrying inflation outlook. The bank said growth continued through the middle of the year, reaching 3.3 per cent in the second quarter, but is expected to slow to 2 per cent in the third. Macklem attributed growth to “solid consumer spending” despite slow population increases. Business investment has also rebounded, driven mainly by activity in the oil and gas sector and spending on machinery and equipment.

“Despite ongoing weakness in sectors affected by US tariffs, exports overall have strengthened, bolstered by robust US demand, higher energy production and increasing signs that businesses are adapting to the changing trade environment,” Macklem said. He warned that new US tariffs will weigh on activity and that growth will likely slow in the fourth quarter. The monetary report also said unemployment has hovered around 6.5 per cent in recent months, suggesting it is “more difficult than usual for the unemployed to find work.”

The Bank of Canada projects the economy will rebound in 2027 after declining over the next few months. Macklem said there is less scope for monetary accommodation as inflation risks rise. “There could be a need to raise the policy rate further, but given the uncertainties we will proceed carefully.”