Markets Put 80% Odds on Bank of Canada Rate Hike Next Week as Loonie Hits Four-Week High

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For months, the Bank of Canada looked like it could afford to wait. That assumption has shifted quickly. As of Wednesday, October 21, swap markets were assigning roughly an 80% probability to a 25-basis-point increase at the Bank’s October 28 decision, which would lift the overnight rate from 2.25% to 2.50%. At the same time, the Canadian dollar was holding close to a four-week high against the U.S. dollar after a sharp rally earlier in the week.

The change in mood has been unusually fast. Higher energy prices, rising long-term inflation expectations and more hawkish language from Governor Tiff Macklem have pushed investors to reconsider how long the Bank can tolerate inflation above its 2% target. Yet Canada’s labour market remains soft and trade tensions are still weighing on the outlook, making next week’s decision far less straightforward than the market odds suggest.

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The biggest story may be how quickly expectations changed. On Monday, swap-market pricing implied roughly an 80% probability that the Bank of Canada would raise its policy rate on October 28, up from about 30% the previous Friday. By Wednesday, that pricing was still holding near 80%. A standard quarter-point increase would take the benchmark rate to 2.50%, reversing the last cut made in October 2025. The Bank has kept the rate at 2.25% through every scheduled decision so far in 2026, including its September 2 meeting.

That does not mean a hike is guaranteed. Market-implied probabilities can move sharply as traders respond to new data, speeches and global events. Still, the repricing matters because it affects bond yields, the Canadian dollar and borrowing costs before the Bank actually does anything. October 28 is also a major forecast meeting: the rate announcement will arrive alongside a new Monetary Policy Report, giving policymakers a chance to update both the inflation outlook and their assessment of economic growth.

Macklem’s Oil Warning Changed the Tone

The turning point came over the weekend. Speaking to reporters from the IMF meetings in Bangkok, Governor Tiff Macklem said the Bank expects to raise its quarterly inflation forecast significantly because crude oil and refined petroleum prices have remained persistently high. He also warned that the longer energy disruptions continue, the greater the risk that price pressures spread beyond gasoline and become more persistent. That language landed differently from the Bank’s earlier willingness to look through what appeared to be a largely energy-driven inflation shock.

The contrast with July is important. In its July Monetary Policy Report, the Bank projected inflation would ease to roughly 2.5% in the second half of 2026 and return to the 2% target by early 2027, an outlook that depended partly on oil prices and gasoline margins declining. The Bank now faces a less friendly energy backdrop. Macklem has framed the October decision around a basic question: whether inflation will move back toward target on its own or whether higher interest rates are needed to push it there.

Headline Inflation Is 3.1%—But the Details Are Messier

Statistics Canada’s September inflation report gave both sides of the rate debate something to work with. The Consumer Price Index rose 3.1% from a year earlier, accelerating from 3.0% in August. Gasoline was the main driver: prices at the pump were 27.8% higher than a year earlier, compared with a 22.8% increase in August. On a monthly basis, the all-items index increased just 0.1%, while seasonally adjusted CPI rose 0.4%.

Strip gasoline out, however, and the picture looks much calmer. CPI excluding gasoline increased 2.2% year over year, down from 2.4% in August. The Bank of Canada’s preferred core measures were also comparatively contained in September, with CPI-trim at 1.8% and CPI-median at 1.9%. That helps explain why a rate hike remains debatable even with headline inflation above the Bank’s target. Policymakers are not simply reacting to one number; they are trying to determine whether the energy shock is beginning to spread through a broader range of prices.

Inflation Expectations Are Becoming the Bigger Risk

One reason markets reacted so strongly this week is that the Bank’s own surveys showed concern moving beyond current gasoline prices. In the third-quarter Canadian Survey of Consumer Expectations, long-term inflation expectations rose to match already elevated shorter-term expectations. Consumers continued to identify trade tensions and energy prices as major sources of inflation, and expectations at all horizons moved higher following the breakdown of Canada-U.S. trade talks. That matters because persistent changes in expectations can influence future spending, wage demands and pricing decisions.

Businesses are sending a similarly complicated signal. The Bank’s Business Outlook Survey found that expectations for input-cost and selling-price growth had moderated but remained elevated. Roughly half of firms facing larger-than-normal cost increases planned to pass some or all of those increases on to customers. Firms surveyed after trade negotiations broke down also reported higher inflation expectations alongside rising oil prices and new tariffs. The surveys do not prove inflation will remain elevated, but they increase the risk that supposedly temporary shocks begin influencing longer-term economic behaviour.

The Loonie’s Rally Is Really a Rates Story

The Canadian dollar has been one of the clearest market expressions of the shift. On Tuesday, the loonie strengthened to around C$1.403 per U.S. dollar, its strongest intraday level since September 22. It then held close to that four-week high on Wednesday at about C$1.4050, equivalent to roughly 71.17 U.S. cents. A softer U.S. dollar helped, but changing expectations for Canadian interest rates were an important force behind the rally.

The mechanism is straightforward: if investors believe Canadian interest rates will be higher than previously expected, Canadian-dollar assets can become relatively more attractive. That shift has narrowed part of Canada’s yield disadvantage versus the United States. The gap between Canadian and U.S. two-year government bond yields narrowed to roughly 146 basis points from around 160 basis points earlier in October as rate-hike bets increased. Political uncertainty also eased after Alberta’s referendum resulted in a decisive vote to remain in Canada. Together, those developments removed several pressures that had recently weighed on the currency.

Oil Is Both a Tailwind and a Problem for Canada

Oil makes the Bank of Canada’s job unusually difficult because Canada is an energy exporter while Canadian households and businesses still feel higher fuel costs directly. Elevated crude prices can support export income, investment in the energy sector and government revenues, particularly in producing provinces. That can strengthen parts of the domestic economy even while consumers face more expensive gasoline and businesses absorb higher transportation and energy-related costs.

For monetary policy, the concern is not simply the initial rise in gasoline prices. The larger risk is persistence. The Bank had been looking through much of the direct impact of higher gasoline prices because broader measures of inflation remained relatively contained. But the longer energy prices stay elevated, the greater the possibility that businesses pass costs through and households adjust their expectations. A stronger Canadian dollar can offset some of the pressure by making imported goods cheaper over time. The trade-off is that currency strength can also make Canadian products relatively more expensive for foreign buyers, complicating the outlook for exporters.

The Economy Is Still Soft Enough to Make a Hike Risky

The strongest argument for caution can be found in the labour market. Canada lost 68,000 jobs in September after employment declined by 42,000 in August, while the unemployment rate edged up to 6.5%. September’s losses included both full-time and part-time positions, with declines in educational services, health care and social assistance, and manufacturing. Hiring intentions in the Bank of Canada’s latest Business Outlook Survey also remained soft, with most businesses expecting to keep staffing levels unchanged.

Growth indicators are not signalling an overheated economy either. Real GDP by industry was essentially unchanged in July after stronger growth during the second quarter. Trade tensions introduce another source of weakness: the Bank’s September deliberations noted that new U.S. tariffs, countermeasures and broader uncertainty could hurt confidence, business investment and hiring. That is the dilemma facing policymakers. Raising rates could reduce the risk of inflation becoming entrenched, but it would also tighten financial conditions in an economy where labour demand is subdued and several interest-sensitive sectors remain vulnerable.

What a Quarter-Point Hike Would Mean for Canadians

For households, the difference between 2.25% and 2.50% may look small on paper, but the Bank’s policy rate sits near the beginning of the chain that determines many commercial borrowing costs. Changes in the overnight rate influence prime rates and can flow through to variable-rate mortgages, lines of credit, business loans and deposit rates. Borrowers with floating-rate debt generally feel policy changes more directly than homeowners whose mortgage rate is fixed until renewal.

The impact would therefore be uneven. Some variable-rate mortgage holders could see payments rise or a larger portion of existing payments directed toward interest, depending on the structure of their loan. Prime-linked lines of credit and other floating-rate borrowing could also become more expensive if lenders pass through the increase. Savers may receive somewhat better returns on certain deposits. The purpose of tighter policy is to reduce demand and keep inflation from becoming entrenched, but its effects are not immediate. For households already managing high living costs, even a modest increase would add another financial pressure before lower inflation delivers much relief.

October 28 Could Reset the Rate Path for Months

The decision next Wednesday will be about much more than whether the Bank moves by 25 basis points. The new Monetary Policy Report will reveal how substantially policymakers have lifted their inflation forecast, how they now view the path for oil prices and whether trade-related economic weakness is expected to offset part of the inflation impulse. Investors will also examine the statement for clues about December 9, the final scheduled Bank of Canada rate decision of 2026. A hike accompanied by cautious language could send a very different message from a hike that points toward a broader tightening cycle.

The reverse is true if the Bank holds. With markets assigning a high probability to an increase, leaving the rate unchanged could prompt a reversal in Canadian bond yields and the loonie unless policymakers offer a convincingly hawkish explanation. A hike itself may also generate a muted currency reaction because much of it is already reflected in market pricing. For borrowers, businesses and investors, the bigger question is whether October 28 represents a one-off adjustment—or the beginning of a new period of Canadian monetary tightening.

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