The probability of a rate hike by the Bank of Canada next week surges to 87% as inflation expectations rise; multiple institutions shift to betting on a 25 basis point rate increase.

According to Trading Finance News, following the latest survey by the Bank of Canada indicating a rise in consumers' long-term inflation expectations, an increasing number of economists and traders anticipate the Bank of Canada will raise interest rates at next week's monetary policy meeting. Despite Canada’s latest inflation data coming in below market expectations, bets on a rate hike continue to increase, with the overnight rate swap market showing traders now see an 87% chance of a Bank of Canada rate hike on October 28.

On Monday, the Bank of Montreal, RBC Dominion Securities under Royal Bank of Canada, and Desjardins Group all adjusted their previous interest rate forecasts, now expecting the Bank of Canada led by Governor Macklem to raise rates by 25 basis points at the October 28 policy meeting, bringing the policy rate up to 2.5%.

Earlier that day, data released by Statistics Canada showed the inflation rate accelerated to 3.1% year-on-year but remained below economists’ expectations from media surveys. However, the lower-than-expected inflation data did not ease concerns in the market over further tightening of monetary policy, and Canada’s bond market continued to see widespread selling pressure.

As of Monday, the probability of a Bank of Canada rate hike next week reflected in the overnight rate swap market had risen to 87%, up from nearly 70% earlier that day. Bank of Montreal economist Shelly Kaushik stated in a report that although the day’s CPI (Consumer Price Index) figures were below expectations, given the ongoing trade war and persistently high energy prices, inflation risks remain tilted to the upside and there is currently no sign that these shocks are coming to an end.

Another key reason for this shift in market expectations is the Bank of Canada’s latest business and consumer outlook survey released Monday. The survey shows Canadian consumers’ long-term inflation expectations are rising. Meanwhile, about half of the companies surveyed said they plan to pass all or part of the costs from rising oil prices and increased tariffs on to consumers.

This result has raised concerns in the market that the impact of energy price increases may no longer be limited to a small number of goods such as gasoline but may gradually be passed through to a wider range of goods and services, driving sustained overall inflation upwards.

Desjardins Group Macro Strategy Director Royce Mendes stated that central bank policymakers can no longer ignore the impact of high energy prices on inflation.

He pointed out that companies have endured high input costs for long enough, so the institution now believes that broader consumer price increases may be imminent. Meanwhile, consumers’ long-term inflation expectations have risen to levels not seen since the most severe price surges during the Covid-19 pandemic, highlighting even more the necessity for central bank action.

In addition to the above institutions, Scotiabank further strengthened its judgment for a rate hike next week after Monday’s data release. Manulife Financial continues to expect the Bank of Canada to raise rates twice consecutively in October and December.

Derek Holt, head of capital markets economics at Scotiabank, commented that if financial markets have largely priced in the expectation of a rate hike, then the Bank of Canada is likely to deliver on this expectation. If the central bank ultimately decides to hold, it may lead to an easing of financial conditions, which under current inflation risks would be difficult to justify.

However, despite bets on a rate hike constantly increasing, there are still clear divisions among economists. Recent media surveys show that most economists interviewed still expect the Bank of Canada to keep rates unchanged at next week’s meeting.

The Bank of Canada has previously warned that if energy prices remain high and there is more evidence showing inflationary pressures are spreading from gasoline prices to other goods and services, the central bank might need to further increase borrowing costs.

Last Saturday, Macklem stated in a conference call with reporters that there are still no signs that the conflict in the Middle East is being resolved. He also pointed out that rising energy prices triggered by the conflict are not only pushing inflation higher but are also boosting Canada’s exports, income, government fiscal revenues, and investment.

This means the impact of rising energy prices on Canada’s economy is dual: on one hand, high oil prices may support economic growth by increasing energy export revenues; on the other hand, persistently rising energy and business operating costs may also drive broader inflationary pressures.

With the October 28 rate decision approaching, the Bank of Canada faces increasingly complex policy choices. The market’s focus has shifted from whether the latest CPI data is below expectations to whether the cost pressures from energy prices and tariffs are forming sustained inflation risks. If the Bank of Canada ultimately decides to raise rates, it will mark a further shift in its monetary policy toward curbing inflationary pressures.