Bank of Canada raises interest rates for the first time in more than three years, lifting the benchmark rate to 2.5% and warning of possible further hikes ahead.

The Bank of Canada announced on Wednesday that it raised its benchmark overnight rate to 2.5%, the first rate hike in more than three years, to address inflation risks stemming from sustained increases in energy prices. The central bank also warned that further rate increases may be needed in the future, but given significant uncertainty in the economic outlook, subsequent policy adjustments will remain cautious. The rate hike was in line with broad market expectations and consistent with the consensus of economists in media surveys. In its policy statement, the Bank of Canada said the Governing Council decided to raise the policy rate primarily to reduce the risk that persistently elevated energy prices would pass through broadly to prices of other goods and services. The central bank stated: "Further increases in the policy rate may be necessary in the future, but given current uncertainty, the Governing Council agreed unanimously to proceed cautiously." Since September of this year, the Bank of Canada has become increasingly concerned about oil price increases triggered by the Middle East conflict, particularly fearing that rising energy costs will gradually pass through to other goods and services, causing inflationary pressures to broaden further. Bank of Canada Governor Macklem said in prepared remarks that given the marked deterioration in the inflation outlook while the Canadian economy continues to show some resilience, raising the policy rate was necessary to reduce the risk that rising energy prices would evolve into broad-based inflation. Inflation expectations sharply revised up; return to 2% target not expected until mid-2028 The latest Monetary Policy Report, released alongside the rate decision, showed that the Bank of Canada significantly raised its future inflation expectations. The central bank now expects Canada's consumer price index (CPI) to rise 3.1% year-on-year in 2027, well above its previous forecast of 2.0%. At the same time, the central bank expects inflation to return to its 2% policy target only by mid-2028, indicating that the impact of rising energy prices on overall prices may be more persistent than previously expected. Macklem noted that the main basis for this rate hike was that energy prices have already risen and are expected to remain elevated for an extended period, while cost pressures facing businesses are also accumulating. He said the Governing Council believes the room to continue maintaining accommodative monetary policy has narrowed. The latest Monetary Policy Report also disclosed some analysis results from the Bank of Canada's new forecasting tool, Prima. The model shows that rising costs of production inputs such as energy may gradually pass through to consumers through corporate pricing, causing price increases to remain elevated for a longer period. However, Macklem also revealed that the central bank discussed the possibility of holding rates steady at this meeting. Reasons supporting a pause included that the current inflation increase remains concentrated in the energy sector, the Canadian economy still has some slack, and the tariff dispute with the United States could continue to weigh on economic growth. Macklem emphasized that the Governing Council agreed to make rate decisions on a meeting-by-meeting basis going forward, based on the economic data and conditions available at each meeting. Growth forecasts raised, but employment and housing markets still under pressure Despite rising inflation risks, the Bank of Canada's assessment of future economic growth has improved somewhat. According to the latest projections, the Canadian economy is expected to grow 1% in 2026 and 2% in both 2027 and 2028. By comparison, the central bank previously projected 0.7% growth in 2026 and 1.8% growth in both 2027 and 2028. The central bank said the upward revision to growth forecasts was partly due to economic support measures introduced by the federal government, including the "productivity super deduction" tax incentive implemented by Prime Minister Carney's government, as well as accelerated progress on major construction projects. However, the overall foundation for Canada's economic recovery remains fragile. Recent data shows that Canada's job market has shed positions for two consecutive months, while U.S. tariff policies and declining immigration levels are also putting pressure on some industries. Meanwhile, the housing market remains weak. It is worth noting that the Bank of Canada did not provide a forecast for core inflation pressures this time. Muted market reaction; economists expect another rate hike in December Financial markets reacted relatively calmly after the Bank of Canada announced its rate decision. The Canadian dollar changed little, at C$1.4046 per U.S. dollar. Since October, the loonie has appreciated about 1.3% against the U.S. dollar. Canada's bond market also showed no significant movement, with the two-year government bond yield edging slightly lower but remaining within the day's trading range. Meanwhile, the Middle East situation remains an important source of uncertainty affecting Canada's monetary policy outlook. Currently, there is no clear sign of an end to the Iran war, and international oil prices remain near the highs seen at the outbreak of the conflict. As of Wednesday morning, Brent crude was slightly below US$115 per barrel. Charles St-Arnaud, chief economist at Servus Credit Union, said that although Macklem did not explicitly commit to further rate hikes, he would be surprised if the Bank of Canada did not raise rates again in December. St-Arnaud believes that for the central bank to choose to pause, it would likely need to see a clear weakening in economic activity or inflation rising less than expected. Overall, the Bank of Canada's rate hike marks a renewed shift toward tightening in its monetary policy. Although growth forecasts have improved somewhat, persistently elevated energy prices and their potential inflationary pass-through effects have become the central bank's primary policy concern. The future path of interest rates will depend on changes in energy prices, inflation data, and economic activity. If high energy costs continue to pass through to prices of other goods and services, the Bank of Canada may need to take further action to ensure inflation ultimately returns to its 2% target.