Economists are urging caution against market expectations that the Bank of Canada will raise interest rates later this year, citing soft economic data and a technical recession. Most analysts believe the central bank will keep its key rate unchanged at 2.25 percent during its upcoming decision this Wednesday, marking the fifth consecutive hold.
Market Expectations vs. Economic Reality
Following the Bank of Canada's April meeting, markets priced in up to 2.5 rate hikes after Governor Tiff Macklem mentioned the possibility of "consecutive" increases if oil prices rose. However, subsequent softer economic indicators and tamer inflation have reduced those bets to 1.5 hikes. Despite this adjustment, many economists still view market pricing as overly optimistic.
"Canada is in a technical recession, and the labour market remains soft with net job losses year to date, keeping the bar for hikes high," said Carlos Capistran, an economist at Bank of America. "With inflation expectations likely to remain well anchored, we expect the BoC to stay on hold and recommend continuing to fade market pricing of BoC hikes."
Diverging Views Among Major Banks
Most of Canada's largest banks, including Bank of Montreal, CIBC, Toronto Dominion, and Royal Bank of Canada, anticipate the central bank will maintain the current rate throughout the year. However, Bank of Nova Scotia stands out by forecasting 50 basis points of hikes in the fourth quarter of 2026 and another in early 2027, which would bring the rate to 3 percent.
"We're the only shop in Canada that called the market move toward pricing hikes in 2026 forecasts dating back to last November," said Derek Holt, head of Scotiabank Capital Markets Economics.
In contrast, Royce Mendes, head of macro strategy for Desjardins Group, argues that the market is mispriced. He points to signs of a "classic demand shortfall in the economy" and believes the Bank of Canada should no longer worry about a tradeoff between high inflation and low growth. Instead, the central bank should focus on potential further deterioration in demand.
Risks and Forward Guidance
Mendes also highlighted the "under-appreciated" risk from the upcoming Canada-United States-Mexico Agreement (CUSMA) review. He noted that it now appears likely the three countries will not agree to a 16-year extension by the July 1 deadline, which would prolong economic uncertainty.
With no rate change expected on Wednesday, observers will closely monitor the Bank of Canada's language. Mendes advised policymakers to avoid reiterating the need for "consecutive" rate increases, calling the previous mention a "communications misstep." He warned, "Traders should beware that the Bank of Canada has a history of misguiding markets."
