Bank of Canada expected to raise interest rate amid oil price surge

The Bank of Canada is widely expected to increase its benchmark interest rate on Wednesday, which would be its first hike in three years. Governor Tiff Macklem has signalled growing concern that high oil prices could push inflation higher. Financial markets now see a nearly 90 per cent chance of a quarter-point increase, a rapid shift from odds of about 35 per cent just days ago. This potential move comes as the Canadian housing market remains weak and unemployment is raised.

Markets recalibrated their expectations after Macklem made hawkish comments at an International Monetary Fund meeting in Bangkok on Oct. 17. He told reporters that if oil prices persist around US$100 per barrel, inflation would likely drift upward from its current level of 3 per cent. The bank is expected to publish a higher inflation forecast in its upcoming Monetary Policy Report. Since that call, oil prices have climbed further, with Brent Crude reaching a six-month high of US$116 a barrel last Friday.

Some economists argue the latest economic data does not clearly support a rate increase. The annual consumer price index rose to 3.1 per cent in September from 3 per cent in August, but the increase was primarily due to a sharp monthly jump in gasoline prices. When energy is excluded, the inflation rate actually eased to 2.2 per cent. "In my view, the data on aggregate is not convincing to hike," said Jeremy Kronick of the C.D. Howe Institute. "So to me, the market is reacting almost entirely to Governor Macklem's comments in Bangkok."

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Kronick noted, however, that rising inflation expectations among consumers and businesses could justify action. The bank's recent surveys showed a sharp increase in longer-term inflation expectations and more firms planning to pass higher costs to customers. "You can look through supply-side price shocks up to the point where expectations start to become de-anchored," Kronick said. "But once you get into that situation, especially with longer-term inflation expectations, then you have to move."

The central bank's policy rate has been held at 2.25 per cent since last October. Avery Shenfeld, chief economist at CIBC, said a rate hike could be prudent if oil prices stay high and trade talks with the U.S. go well. "But it could prove to be a policy mistake if the trends go in the other direction for both oil prices and trade policy," Shenfeld said. The bank has surprised markets with its decisions before, leaving some uncertainty about Wednesday's outcome. Looking beyond this week, markets anticipate four quarter-point rate increases by the end of 2027, which would bring the policy rate to 3.25 per cent. Nathan Janzen, assistant chief economist at RBC, said this pricing reflects an expectation that the Canadian economy will normalize. "If the economy is normalizing, then there's room for interest rates to normalize," he said.

Janzen added that for many borrowers, the exact timing of the first hike matters less than the overall direction. Interest rates on longer-term bonds, which influence fixed mortgage rates, have already risen in recent months. "Shifting the timing by three months doesn't make that big of a difference for a five-year or 10-year [bond]," Janzen said. "As long as they're going to hike sometime within the next few months, then for a lot of households and businesses that are borrowing at fixed rates, it doesn't make that big of a difference when that initial interest rate hike comes." Other central banks, including the U.S. Federal Reserve, raised rates last month in part due to high energy costs. The Fed is also scheduled to make a rate decision on Wednesday, but it is widely expected to hold steady ahead of the U.S. midterm elections next month. Yadude Books reported earlier this month that soaring diesel prices are adding new inflation pressure beyond the oil shock.

With files from The Globe and Mail