Economists are cautioning against market expectations that the Bank of Canada will raise interest rates later this year. Most believe the central bank will keep its benchmark rate unchanged at 2.25 percent for the foreseeable future, despite recent market pricing that suggests otherwise.
Market Expectations vs. Economic Reality
Following the Bank of Canada's April meeting, market bets on rate hikes surged after Governor Tiff Macklem mentioned the possibility of "consecutive" increases in a scenario where oil prices climb higher. Traders initially priced in 2.5 hikes for the year, but softer economic data and tamer inflation have since reduced those expectations to 1.5 hikes. However, most economists argue that even this is too high.
"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
The Bank of Canada's next decision is due this Wednesday, and it is widely expected to hold rates steady for the fifth consecutive time. For the remainder of the year, economists and markets are at odds. Most of Canada's big banks, including Bank of Montreal, CIBC, Toronto Dominion, and Royal Bank of Canada, expect no rate changes in 2026.
However, Bank of Nova Scotia forecasts 50 basis points of hikes in the fourth quarter of 2026 and another in early 2027, which would bring the rate to 3 percent. Derek Holt, head of Scotiabank Capital Markets Economics, noted that his bank was the first to predict the market move toward pricing hikes in 2026, dating back to last November.
Underappreciated Risks and Communications Missteps
Royce Mendes, head of macro strategy at Desjardins Group, argues that the market is mispriced. He points to 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 focus should be on what is needed if demand deteriorates further.
Mendes also highlights the "under-appreciated" risk of the upcoming Canada-United-States-Mexico-Agreement review. A negative outcome, he says, is the "single greatest risk to the Canadian economy." It now appears unlikely that the three countries will agree to a 16-year extension by the July 1 deadline, which would prolong uncertainty.
With no rate move expected this Wednesday, observers will scrutinize the Bank of Canada's language. Mendes cautioned that the bank should avoid repeating the need for "consecutive" rate increases, calling the previous mention a "communications misstep." He added, "Traders should beware that the Bank of Canada has a history of misguiding markets."
