Why the Bank of Canada's next move is more likely to be a hike
The Bank of Canada is expected to keep its policy rate on hold at 2.25 per cent in 2026, but if it does make a move, economists say it is more likely to be a hike.
Most of the country’s big banks agree that the central bank will enter the new year waiting to see how past rate cuts play out in the economy, especially with some noisy data on the horizon.
“There are a lot of distortions coming up in the next few inflation numbers,” said Desjardins Group chief economist Jimmy Jean, citing last year’s GST holiday. “They’re just sort of trying to distinguish the signal from the noise … but also monitoring the job numbers and GDP.”
At its last rate decision of the year, Bank of Canada governor Tiff Macklem said the policy rate was at “about the right level” to keep inflation at around two per cent and to support the economy through a period of structural adjustment brought on by the trade war with the United States.
In a forecast released in October, the bank said it expects the Canadian economy to grow by 1.2 per cent in 2025 and 1.1 per cent in 2026. The bank also expects the headline consumer price index to be 2.2 per cent by the end of 2026 and 2.1 per cent by the fourth quarter of 2027, with core inflation returning to near target at 2.1 per cent by the end of 2027.
Royal Bank of Canada senior economist Claire Fan said while the Canadian consumer has shown some resilience in 2025, business investment continues to struggle, with that trend expected to continue into 2026.
“Because we talk about trade impacts, really in a cyclical way, a lot of times, we think it impacts exporters and producers, which they definitely do,” she said.
“But I think business investment is one way that perhaps it’s going to have a longer-run impact on the Canadian economy, because if businesses don’t invest right now, they’re not going to be able to grow very quickly decades down the road.”
The unemployment rate also dropped in November to 6.5 per cent, down from its peak of 7.1 per cent in September, and the Canadian economy added 181,000 jobs this fall. But most of those new jobs were part-time.
“I don’t think it’s improved as much as the headline numbers look, because these are mainly part-time jobs,” said former Bank of Canada deputy governor Paul Beaudry, now a professor at the University of British Columbia.
Beaudry added that better a indication of weakness or health in the labour market is total hours worked, which he said have declined.
Downside risks to the Canadian economy remain, however, including uncertainty around the review of the Canada-United-States-Mexico Agreement ( CUSMA ) in the summer of 2026. Currently, most Canadian goods are exempted from the 35 per cent U.S. tariffs, because they are CUSMA compliant and any change to the trade pact could send a chill across the economy. Sectoral tariffs meanwhile, remain in place on Canadian lumber, auto, steel and aluminum sectors.
Population growth has also slowed, which will continue to be a headwind.
“Population growth is going to grow to almost nothing in 2026, so that’s one of the key headwinds that’s going to really hurt aggregate demand,” said Fan. “And outside of that, we still don’t get a lot from productivity growth either.”
As to when the central bank might start raising rates, there is little consensus.
Notably, the Toronto-Dominion Bank, Canadian Imperial Bank of Commerce, Bank of Montreal, RBC and Desjardins expect the central bank to hold rates where they are for the entirety of 2026.
But bond markets have increased bets for a hike in the back half of 2026, with the Bank of Nova Scotia and the National Bank of Canada also forecasting 50 basis points of hikes to the overnight rate by the end of the year.
Most economists remain skeptical, given the downside risks to the economy caused by tariffs and the U.S. being in an easing cycle.
“I just don’t see it,” said Beaudry. “Especially with the U.S. being in a cutting cycle next year, the idea that we’d increase rates when the U.S. is decreasing rates, and the fact that we have inflation around two per cent and we have high unemployment.”
Looking to 2027, RBC and Desjardins do expect the Bank of Canada to hike the policy rate by 100 basis points bringing it to 3.25 per cent by the fourth quarter.
Jean said he expects the bank to raise rates in 2027 because fiscal stimulus will start to have a more palpable effect on economic growth.
“We also assume a fairly benign outcome from the CUSMA revision process, though recognizing the high uncertainty,” he said. “With the growth picture solidifying, the Bank of Canada will probably interpret risks around its inflation target as being balanced, justifying moving back to a more decisively neutral stance.”
• Email: jgowling@postmedia.com