Bank of Canada Raises Rates to 2.5% as Oil Costs Persist

Higher fuel and import costs have raised the Bank’s inflation forecast even as U.S. tariffs threaten growth. The quarter-point increase is meant to stop those costs spreading further.

The Bank of Canada has raised its benchmark interest rate for the first time since July 2023. On October 28, it moved the target for the overnight rate from 2.25 to 2.5 per cent, while new U.S. tariffs cast doubt on the strength of the next few months.

The immediate issue is the price of fuel. Inflation driven largely by energy costs has lasted longer than the Bank expected, and it fears more firms will pass higher input costs to customers. Raising rates may add to borrowing costs before that wider inflation has fully appeared.

The forecast changed more than the interest rate

Canada's consumer price index rose 3.1 per cent over the 12 months to September. Gasoline prices were up 27.8 per cent, while inflation excluding gasoline was 2.2 per cent. Those are observed September figures, not a prediction about what households will pay later.

The more consequential revision is in the Bank's October Monetary Policy Report. It now projects inflation will average 3.1 per cent in 2027, up from the 2.0 per cent it anticipated in July. It expects the annual rate to reach roughly 3½ per cent by the end of this year, then move back near its 2-per-cent target around the middle of 2028. These are forecasts, with substantial risks in either direction.

The revision starts with global energy markets. Oil prices have stayed high amid conflict and disrupted supplies in the Middle East, and unusually wide refinery margins have kept fuel prices elevated. Higher diesel and other fuel costs make goods more expensive to transport and services more expensive to provide. Bank research traces how a shock that begins at the pump can turn up later in invoices between businesses and eventually at the cash register.

In its survey evidence, businesses report that they have absorbed much of their recent cost increase rather than charging customers more. They expect to pass on a greater share over the next 12 months. That expectation is not a price increase already measured at the checkout.

The argument for holding was real

Governing Council did not treat October's decision as obvious. Governor Tiff Macklem said it considered both holding the rate and raising it.

The argument for holding was credible. Inflation remains concentrated in energy and energy-intensive services, including air travel. Core inflation measures are still close to 2 per cent, and the Bank estimates that the economy has spare capacity. Raising borrowing costs could weaken demand at a time when new U.S. tariffs are already hurting exposed exporters and their workers.

The argument for raising rates was the duration of the shock. Fuel, freight and imported-input costs have remained high long enough that the Bank expects more businesses to pass them along. The Governing Council judged that reducing the risk of a broader and more persistent rise in prices justified a quarter-point increase now.

Trade policy makes the choice harder. According to the Bank's October assumptions, roughly 80 per cent of Canadian goods exports to the United States remain tariff-free, but new duties have raised the estimated average U.S. tariff on Canadian goods from 5.0 per cent in July to 7.5 per cent. The damage is concentrated in exposed industries, while uncertainty can discourage investment well beyond them. Canadian counter-tariffs and higher import prices add cost pressure here at home.

The Bank’s October projection puts Canadian growth at 1 per cent in 2026 and 2 per cent in both 2027 and 2028. That is a somewhat stronger national growth outlook than in July, but it says little about how quickly individual tariff-exposed businesses will recover.

What a quarter-point increase means for Canadians

A 2.5-per-cent overnight rate is not a 2.5-per-cent mortgage rate. The policy rate influences what commercial lenders charge and pay, but the timing and size of any change depend on the product and contract. Bank of Canada research on mortgages explains that borrowers with variable rates and variable payments can see payments adjust when a lender changes its prime rate. Those with variable rates and fixed payments may instead pay more interest and less principal unless their contract requires a payment change. An existing fixed-rate mortgage usually keeps its contracted rate until renewal.

People arranging new loans and businesses using lines of credit may face higher financing costs if lenders adjust rates. Savers may see different deposit offers. None of those changes is guaranteed to match the Bank’s quarter-point move or arrive the same day.

A business facing higher diesel bills or imported-part prices could also find it more expensive to finance inventory or new equipment. The impact depends on its borrowing terms and ability to absorb costs. That is one practical price of the Bank’s decision, even if the decision helps contain inflation later.

What could change the decision in December

The Bank’s next scheduled rate announcement is December 9. It has said another increase may be needed, but it has not committed to one.

Three developments deserve attention: whether oil and refinery costs ease; whether businesses actually begin raising a wider range of consumer prices; and whether trade restrictions further weaken spending, jobs and investment. The Bank's risk assessment allows for both more persistent inflation and a sharper slowdown. Neither outcome should be presented as inevitable.

We examined the Bank's trade-war dilemma in September when it kept interest rates on hold. October supplies the next piece of evidence: the Bank has decided that waiting carries a greater inflation risk than a modest increase in borrowing costs. Canadians will find out over the coming months whether business prices and economic activity support that judgment.