Bank of Canada raises key interest rate to 2.5 percent

Explainer

The Bank of Canada raised its key policy interest rate by 25 basis points to 2.5 percent on Wednesday. It is the central bank's first rate hike since July 2023. Governor Tiff Macklem said the increase was needed to reduce the risk that high energy prices spill over into broader inflation. The bank warned that more increases could follow, but said it would proceed carefully given economic uncertainties.

Statistics Canada reported the consumer price index rose 3.1 percent in September from a year earlier. Energy prices were up 19.0 percent over the year, with gasoline up 27.8 percent. "Inflation is projected to remain above 3% through much of 2027, longer than anticipated in the July Report," the bank said in its Monetary Policy Report. It expects inflation to settle around its 2 percent target by the middle of 2028. Macklem said the outlook for inflation has deteriorated since the bank's July report. "With the outlook for inflation substantially higher and the economy showing resilience, an increase in the policy rate is needed to reduce the risk that elevated energy prices could spill over and become generalized inflation," Macklem said in prepared remarks. He noted the persistent war in the Middle East means global oil prices will remain higher for longer.

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What does the rate hike mean for mortgages?

The higher overnight rate will soon be reflected in lenders' prime rates, which will increase by 25 basis points. Clay Jarvis, a mortgage expert at Ratehub.ca, said the lowest five-year variable mortgage rate will likely increase from 3.45 percent to 3.70 percent. "Fixed mortgage rates are not directly affected by Bank of Canada rate decisions," Jarvis said. "The best 5-year fixed rate today is 4.34%."

Jarvis noted that fixed rates are raised partly because investors were anticipating a rate hike. He said both fixed and variable rates could rise further this year, so home buyers and renewing homeowners should consider getting a pre-approval. "Locking in a rate is a reliable hedge against paying more for a mortgage," he added. For a homeowner with a variable rate mortgage, a 0.25 percent increase adds about $80 to a monthly payment on a roughly $618,000 mortgage.

How will the economy and housing be affected?

The bank expects higher input and financing costs to keep housing activity weak while boosting shelter inflation. Residential investment, which includes spending on new home construction and substantial renovation, is forecast to average less than 1 percent growth in 2027 and 2028. In contrast, overall GDP growth is expected to be roughly 2 percent for both years. "Weak demand and high input costs are the reasons they cite," according to the bank's analysis. A lack of affordability, slow population growth, and rising borrowing costs are seen hitting demand. Higher energy costs and imported input costs will make construction more expensive. The bank's report also pointed out the unemployment rate has hovered around 6.5 percent in recent months, suggesting it is "more difficult than usual for the unemployed to find work." Macklem said growth in the Canadian economy reached 3.3 percent in the second quarter but is expected to slow to 2 percent in the third quarter. He attributed growth to solid consumer spending and a rebound in business investment, primarily in the oil and gas sector. "Despite ongoing weakness in sectors affected by US tariffs, exports overall have strengthened," Macklem said.

What are the risks to the inflation outlook?

The bank identified the rise in energy prices and uncertainty surrounding Canada's trade relationship with the United States as the two biggest risks to increasing costs of living. Of the consumer-facing businesses surveyed by the central bank, 60 percent expect to pass costs on to customers in the next 12 months. "Cost pressures are building and that businesses anticipate passing on more of their increased costs to customers," the bank said. Macklem warned that the fourth quarter will likely show slower growth as "new US tariffs weigh on activity." The price of Brent crude oil averaged $124.96 per barrel in October, about $35 more than in July.

Faye Lucas, Head of Consumer Trust at Koho, expressed concern about the impact on households. "The Bank of Canada's decision to raise rates is aimed at keeping inflation from becoming entrenched, but it lands on households already stretched by grocery bills, higher energy costs, credit card balances and mortgage payments," she said in an email. The next interest rate announcement is scheduled for December 9, 2026. "Looking ahead, Governing Council agreed we would take future decisions one meeting at a time," Macklem said. "There could be a need to raise the policy rate further, but given the uncertainties, we will proceed carefully."

With files from Tree Frog creative, Better Dwelling and BNN Bloomberg