Canadian bond yields surge, TSX falls, as markets and some economists pivot to believing a BoC rate hike is imminent

Money markets are pricing in strong odds that the Bank of Canada will hike its key lending rate next week, in a major rethink of interest rate probabilities in part ignited by governor Tiff Macklem’s hawkish comments on the weekend.

Implied interest rate probabilities in overnight index swaps markets suggest a 75 per cent chance there will be a quarter point rate hike by the bank on Oct. 28, according to Bloomberg data. The market is positioned for an overnight rate of 2.455 per cent at the conclusion of next week’s policy decision, rising to 2.614 per cent by the Dec. 9 decision. The current overnight rate is 2.25 per cent.

That’s a considerable swing from just last week, when markets were pricing in less than 50 per cent odds of a rate hike this coming week, even though they were putting strong odds on a hike by the December meeting.

The slightly softer-than-expected Canadian inflation report this morning had only very modest impact on traders’ reassessment of where borrowing costs are heading.

The Bank of Canada also released surveys this morning that pointed to higher inflation expectations amid increased input costs and elevated selling prices due to trade ‌tensions and ​the Middle East ‌crisis.

Canadian bond yields today are reflecting the reassessment of interest rate move odds. The 2-year yield, sensitive to central bank policy, is up 14 basis points in afternoon trading. That’s four times the move higher today in the equivalent U.S. Treasury, and a large move in one day for bond markets.

The five-year yield - closely watched for its impact on fixed mortgage rates - is up by the same amount, now back to where it started this month after trending lower over the last couple of weeks.

The Canadian dollar is up nearly a third of a U.S. cent for the day, reflecting the reassessment of rate hike odds. The move is notable on a day when the greenback is also mildly higher against major currencies.

For its part, the TSX is underperforming U.S. indexes today, with the interest rate sensitive utilities sector among the worst performers, down 1.6 per cent. Financials are down nearly 1 per cent. Higher interest rates are a challenge for housing, a sector banks generate a big chunk of their revenue from. The S&P/TSX Composite is down 0.8 per cent.

Speaking to reporters on Saturday morning from the International Monetary Fund meeting in Bangkok, Thailand, Macklem said he expects the central bank to revise its inflation forecast higher at its interest rate announcement later this month as the conflict in the Middle East shows no sign of ending and global oil prices remain stubbornly high. Mr. Macklem noted that oil prices have been much higher than the bank expected when it published its last quarterly forecast in July.

Many economists issued notes in the wake of today’s inflation report suggesting the bank will hold next week, putting them at odds with market pricing.

But not all of them.

Scotiabank head of capital markets economics Derek Holt thinks money markets have it right and a rate hike next week is the most likely scenario.

“Backward looking Canadian CPI for one month was probably doomed to be immaterial before it landed given BoC Governor Macklem’s forward-looking warnings,” Holt said in a note. “I believe the trend continues to provide the BoC with a warning that it needs to get on with tightening next week. We forecast the Bank of Canada will hike 25 basis points next week. Markets seem to get this message.”

He continued: “It’s not a slam dunk call but there is probably enough supporting evidence for a hike. BoC Governor Macklem sounds like he’s fading backward looking data in favour of a higher forward-looking inflation forecast and higher inflation risk. The BoC looks at trends, not spot data anyway. If a hike is significantly priced, then they’re likely to deliver one since easing financial conditions by whiffing would be tough to justify.”

Desjardins Securities, meanwhile, in a midday note today changed its policy rate forecast, also predicting a rate hike next week.

“Central bankers can no longer look through the inflationary impact of high energy prices,” Royce Mendes, Desjardins’ managing director and head of macro strategy, said in a note.

“Businesses have faced elevated input costs for long enough that we now believe more broad-based consumer price increases are imminent. Consumers’ longer-term inflation expectations have also risen to levels not seen since the worst of the COVID-era price hikes, reinforcing the need for action,” Mendes said.

“The fact that core inflation has remained around the two percent target is comforting, but it shouldn’t stop the forward-looking central bank from tightening policy in the near term. As a result, we now expect the Bank of Canada to raise its policy rate by 25 basis points later this month. Central bankers cannot reopen the Strait of Hormuz or repair global refining capacity, but they can try to keep localized price pressures from spreading to other goods and services,” Mendes added.

Bank of Montreal, in a note, said it is also now thinking a rate hike next week is the most likely scenario.

“Recent hawkish comments from BoC Governor Macklem suggest a hike could be on the table next week (BMO is now leaning to a 25 bp hike),” said senior economist Shelly Kaushik. “Despite this morning’s milder-than-expected CPI report, inflation risks remain tilted to the upside given the trade war and still-elevated energy prices, with no end in sight to either shock.”

Canada’s annual inflation rate ​rose to 3.1 per cent in September, data showed ‌on Monday, as higher gasoline and diesel prices pushed the consumer price index above the Bank of Canada’s upper limit once again after three months. Analysts polled by ⁠Reuters had ​forecast inflation of 3.2 per cent in September, up from 3% in August.

The Bank of Canada’s key lending rate has not changed since it was last cut in October of 2025.