Is the Bank of Canada about to make a big mistake?

Nothing is set in stone, but it sure looks like the Bank of Canada is poised to start raising interest rates next week.

A rate hike? In this economy?

It would be a controversial move, to say the least. As a policy tool, central banks typically raise interest rates when an economy is at risk of overheating. That’s far from the case right now. Nobody is saying the Canadian economy needs cooling off.

The job market has stalled, wage growth is slowing, GDP forecasts are on the decline, the national housing market is in a five-year recession, and the trade war with the United States remains a potent economic threat.

There is plenty of doubt that the economy can even handle a tightening cycle.

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“We aren’t yet sure that ANY rate hikes will be warranted in the coming year, so moving early could be a step that the bank comes to regret,” Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce, wrote in a report.

The case for a hike ultimately comes down to inflation, which is picking up enough speed to make the bank uncomfortable.

Bank of Canada Governor Tiff Macklem seemed to tip his hand last weekend when he said inflation for 2026 was tracking “quite a bit higher” than the 2.5-per-cent forecast by the bank in July. And he wondered aloud whether inflation is “likely to come back down toward our target on its own.”

The bank then began its customary communications blackout in advance of this Wednesday’s rate announcement, leaving economists to ruminate on what seemed to be a hawkish turn.

Traders quickly pushed the odds of a rate hike to higher than 80 per cent – not quite a slam dunk, but close enough. Markets are now pricing in at least four hikes over roughly the next year.

Bank of Canada’s Macklem expects higher inflation outlook as oil prices remain elevated

If that proves accurate, such a rate-hike path could send a chill throughout the Canadian economy. Borrowing costs would spike, not just for consumers, but for businesses as well, at a time when the country is trying to orchestrate a historic wave of investment.

Spending and consumer demand would get squeezed. The housing market would take another hit as variable mortgages get more expensive. And the country’s growth rate could be further downgraded. The Bank of Canada’s own model forecasts just 0.7 per cent in real GDP growth this year, and 1.8 per cent next year.

The economic consensus does not seem to be on board. Look at a sampling of comments from reports this past week, which are unusually out of sync with how the Bank of Canada seems to be leaning:

• “It was with great reluctance that we threw in the towel and changed our call on the BoC,” Bank of Montreal chief economist Douglas Porter said in anticipation of a rate hike. “We simply succumbed in the face of Gov. Macklem’s intense fixation on headline inflation.”
• The C.D. Howe Institute said its members “saw little evidence of broader price pressures” and find it “difficult to make the case for a hike.”
• Andrew Hencic, senior economist at Toronto-Dominion Bank: “An interest rate hike at this point is premature.”
• Frances Donald, chief economist at Royal Bank of Canada: “The case for the central bank continuing to wait on the sidelines remains compelling.”

It’s not that economic opinion is unanimous – not quite, anyway. Some see the case for hiking rates now. Headline inflation is persistently running well in excess of the Bank of Canada’s 2-per-cent target. The annual pace of inflation ticked up to 3.1 per cent in September, largely because the oil-supply shock in the Middle East keeps pushing up gasoline prices.

And it’s clear why the Bank of Canada might be extra sensitive to persistent cost pressures. Like many central banks, it wrongly treated a spike in prices in 2021 as a temporary blip rather than the generational pricing shock it became.

Central bankers around the world lost some credibility in that episode that they’ve been working to restore ever since. They have no interest in letting higher energy costs spill over into a broader wave of consumer price inflation.

But, “the latest CPI gave precisely zero evidence of such spillover,” Mr. Porter wrote. Most measures of core inflation, which strip out volatile items such as gasoline, sit at 2 per cent or lower, he said.

There is a clear case to be made for being patient. Wait to see if the 110,000 jobs lost in August and September are the start of something more serious. Wait to see what happens with rising bond yields, which are already doing some financial tightening in place of rate hikes. Wait to see if U.S. President Donald Trump follows through with threats to double tariffs on Canadian autos and steel to 50 per cent in about two months.

Five years ago, the Bank of Canada waited too long. That’s no excuse for jumping the gun this time around.