The Bank Of Canada Decision To Raise Rates Aimed At Future Inflation

With today’s’s announcement of a 25 basis point increase in its policy rate, the Bank of Canada started with its customary review of the world economy and then switched to conditions at home. It cited that global economic activity is strong, the US economy continues to expand, the Chinese economy is rebounding, and finally that the eurozone is looking healthier. Hence, the Bank has revised global GDP growth slightly upward to 3.1% in 2026, while growth in 2027 and 2028 remains unchanged from the July projection at 3.2%. The Bank must believe that the world economy—including Canada—can withstand higher interest rates without hurting growth.

At the core of the Bank’s position are Canadian inflation rates, now expected to reach 3.5% by year’s end and continue at 3.1% into 2027. The Bank’s target of 2% is not expected to be reached until well into 2028. Put differently, the Bank does not want to be caught behind the curve on inflation. Fearing the continued impact of higher crude oil prices seeping throughout all sectors, the Bank has chosen to tackle this problem now, rather than later.

However, this policy stance is questionable to the extent that growth is more at risk than the Bank implies. The real concern should be how rate increases affect economic expansion. The Bank acknowledges that:

“The Canadian economy is expected to grow 1% in 2026, and 2% in 2027 and 2028. This is a somewhat stronger overall growth projection than [our] July Report. This forecast is still subject to considerable uncertainty, particularly regarding Canada-US trade relations.”

Not only are these growth numbers hardly worthy of writing home about, but the Bank admits that there remains considerable slack in the economy—there is excess supply of both labour and physical capital, especially outside of the energy sector. Bank economists forecast that the output gap remains around -1%.

 Canada and the US are a long way from resolving the uncertainty regarding the bilateral trade friction which is slowing down growth, even outside those tariff-affected sectors. Canada’s efforts to build new trade alliances with the EU and other countries are a long way off. Growth will continue to come from within and from exports to the US. The former continues to suffer from under-consumption and under-investment, especially in the all-important housing sector. The latter is chiefly benefiting from higher world oil prices and other commodities. In the meantime, the Bank has chosen to protect the economy against widespread inflation down the line, as energy prices permeate all types of goods and services.