A Bank of Canada rate hike could still land in 2026, say economists after inflation reading

Bank of Canada governor Tiff Macklem came across as hawkish in an interview with reporters at an International Monetary Fund meeting and that has economists wondering if policymakers will continue to shrug off above-target inflation.

“The question we’re going to be asking ourselves is, ‘Is inflation likely to come back down towards our target on its own or are we going to have to raise interest rates to influence the path?’” he said this past weekend.

Canada’s headline inflation rose to 3.1 per cent year over year in September, missing estimates of 3.2 per cent, with the increase fuelled by higher prices for gasoline, Statistics Canada said.

The Bank of Canada’s target range for inflation is one per cent to three per cent.

The headline consumer price index (CPI) has been above the central bank’s target for eight of the past nine months, hitting a high of 3.2 per cent in May.

But core measures of inflation, which strip out food and energy, in September slowed to 1.9 per cent month over month and 1.8 per cent year over year from two per cent and 1.9 per cent, respectively.

The Bank of Canada has held its benchmark lending rate at 2.25 per cent for the past seven meetings.

Here’s what economists say the latest inflation data means for the economy, policymakers and interest rates.

“Markets came into this important inflation reading leaning heavily towards a Bank of Canada hike,” encouraged by Macklem’s comments over the weekend regarding inflation, Douglas Porter, chief economist at Bank of Montreal, said in a note on Monday.

Coupled with a warning about a persistent rate of inflation above target, Macklem also said he expected higher oil prices to boost the coffers of Alberta and the federal government while also improving the prospects for the Canadian economy.

The tame core CPI data, however, won’t give markets betting on an October rate much to chew on as there was “zero evidence” higher gasoline prices have spread beyond the pumps, Porter said.

“Even so, the Bank of Canada seems laser-focused on the persistence of headline inflation above three per cent,” he said.

He said it looks like high headline CPI will stick around given higher prices for oil and other products, such as diesel, but the Bank of Canada tends to look ahead.

“One tame current inflation result won’t necessarily stay their hiking hand,” he said.

“The Bank of Canada is still facing an uncomfortable balance,” Abbey Xu, an economist at Royal Bank of Canada, said in a note on Monday.

She said the economy is improving, but remains soft, as evidenced by the loss of jobs in August and September, which suggests a hold on interest rates. The Bank of Canada, however, is on high alert for any signs that elevated overall inflation is spreading to the wider economy and boosting inflation expectations among consumers.

“Softer labour-market data and higher fixed-borrowing costs give policymakers room to remain patient,” she said.

RBC’s base case is for policymakers to hold rates for the rest of the year and then start hiking next year.

“However, recent communications from the Bank of Canada and governor Macklem are denoting more urgency than the data to date might suggest and add to the risk the Bank of Canada chooses to move preemptively,” she said.

“The Bank of Canada increasingly faces a difficult trade-off,” Peter Shannon, senior economist at KPMG Canada, said in a note on Monday.

A slowing job market, an economy operating below its potential and weakening population growth are reasons to hold, but oil prices have climbed further since the Bank of Canada’s last rate announcement in early September, so Macklem’s warnings that inflation risks remain high aren’t likely to evaporate.

“Measures of inflation expectations will move up and demands from markets for central banks to prove credibility are also not going away,” he said.

KPMG expects the Bank of Canada to hold rates at its October meeting, with a hike possibly as soon as December.

“We’re still sitting on a fragile threshold, and it won’t take much to cross it,” he said.