The BoC hikes, but remains cautious
The Bank of Canada raised its policy rate by 25bp to 2.50% this afternoon, its first increase since July 2023, ending a run of seven consecutive holds.
That is, admittedly, at odds with our pre-decision call. As we saw it, underlying inflation is too soft, the labour market too weak and the trade backdrop too fragile to justify tightening at this point. The Bank seemingly agrees with that rationale in part, despite today’s rate rise, with Governor Macklem pushing back on the notion that this represents the clear beginning of a tightening cycle. The result has been minimal loonie movement, even with the benefit of tighter policy.
Looking at the Bank’s own rationale, justification for today’s move is almost entirely an energy story. With the war in the Middle East now in its eighth month, the Bank dropped its prior assumption that oil would fade, a move indicated by Governor Macklem at the IMF meeting in Bangkok, where he signalled a sharply higher inflation forecast.
Indeed, annual headline inflation is now seen near 3.5% by year-end and averaging around 3% in 2027, a full percentage point above the July projection, with a return to target only in mid-2028. The stated aim is to stop higher fuel and imported input costs spreading into broader prices, a point re-iterated in the press conference, with surveys now pointing to greater pass-through over the coming year and near-term inflation expectations rising.
Even so, we see today’s move as premature. Inflation excluding gasoline was just 2.2% YoY in September, and the Bank’s preferred measure of underlying price growth fell to 1.85% YoY in September.
Add a labour market that has shed roughly 110k jobs over two months, and US trade tensions that will weigh on growth, and, in our view, the more prudent choice would have been patience. In any case, it is hard to see today as the first of many moves. We think Macklem’s framing is telling here, noting that decisions will be taken one meeting at a time, and while further hikes could be needed, the Bank will “proceed carefully”.
From an FX perspective, with today’s hike already near fully discounted ahead of time, USDCAD has been left trading little changed post-event.
Looking ahead, however, we remain more dovish than market-implied expectations, skewing loonie risks to the downside. Absent clear evidence of broadening core inflation, we expect the Bank to hold in December, seeing a near-100bp of tightening priced over the next twelve months as overly aggressive. And with the Fed expected to hold at 3.75-4.00% at 18:00 GMT while keeping December live, rate differentials should keep favouring the dollar, leaving USDCAD drifting back towards 1.41-1.42 as December pricing fades, barring a fresh oil spike or a tariff deal.