Financial markets are rapidly adjusting their expectations for the Bank of Canada’s next move. Following hawkish signals from Governor Tiff Macklem, traders are increasingly betting on a policy rate increase during the upcoming October 28 meeting.

Advertisement

The US$100 oil threat and Macklem's Bangkok pivot

Governor Tiff Macklem of the Bank of Canada has signaled a significant shift in how the central bank views energy-driven price volatility. Speaking in Bangkok following an International Monetary Fund meeting,Macklem suggested that the institution may no longer be able to simply "look through" supply-side shocks caused by rising energy costs.

The Bank of Canada is particularly concerned that if oil prices remain near the US$100 mark, inflation could steadily climb above its current 3 per cent level. This comes as the central bank has maintained its policy rate at 2.25 per cent for the past year , attempting to balance energy-driven inflation risks against the economic slowdown caused by trade tensions with the United States.

An 80% probability of an October 28 rate hike

Interest rate swap markets have reacted sharply to the changing sentiment from the Bank of Canada. As the source reported, the probability of a quarter-point rate increase at the October 28 decision surged to 80 per cent,a massive jump from the 35 per cent probability reocrded just days prior.

This market volatility reflects growing concern among Bay Street forecasters.. Royce Mendes, the head of macro strategy at Desjardins, noted that businesses have endured high input costs for long enough that broader consumer price increases may now be inevitable, regardless of current core inflation stability. Mendes suggests that the stability of core inflation should not deter the Bank of Canada from near-term tightening if broader consumer trendds continue to point higher.

The divergence between 3.1% headline inflation and 1.8% core measures

Recent data from Statistics Canada presents a conflicting picture of the Canadian economy. While the annual inflation figure for September rose to 3.1 per cent, this increase was heavily weighted by a 6.1 per cent monthly surge in gasoline costs.

When stripping away volatile energy components, the underlying inflation story looks much more stable. According to the report, the Bank of Canada’s two preferred core inflation measures actually fell to 1.9 per cent and 1.8 per cent respectively. Furthermore, grocery price inflation has shown signs of cooling, dropping to 1.7 per cent from 2.8 per cent in August, driven by lower prices for vegetables and confectionery. This creates a difficult environment for the Bank of Canada, which must balance these stable core figures against rising long-term inflation expectations among Canadian consumers.

Will the Middle East conflict and US trade tensions drive rates higher?

Several critical variables remain unverified and could dictate the Bank of Canada's final decision on October 28. While the central bank is weighing the upside risks of the Middle East war, it must also consider the downside risks to economic growth stemming from trade tensions with the United States.

The report leaves several questions unanswered, specifically regarding how much the recent collapse in trade talks between Ottawa and Washington will impact business inflation expectations. Furthermore, it remains to be seen whether the Bank of Canada will officially revise its inflation forecast upward later this month as Macklem has suggested, or if the stability of core inflation will provide enough cover to maintain the current 2.25 per cent rate.