Monetary Policy: The Bank of Canada Sets the Stage for Rate Hikes

The Bank of Canada is underestimating persistent inflationary pressure and has laid the groundwork for rate hikes.

• The Bank held its policy rate at 2.25% on September 2, its seventh consecutive hold since December 2025, while GDP grew 3.3% in the second quarter and unemployment fell to 6.4% in July.
• Consumption growth averaged 2.4% over the past five quarters, exceeding productivity growth, and domestic demand has outpaced productivity, which Addenda argues is inconsistent with the Bank's claim that the economy remains in excess supply.
• Headline CPI has stayed near 3%, ex-gas inflation was 2.2% in July, and three-month annualized core CPI had already reached 3.3%, despite the Bank emphasizing more favourable year-over-year measures.
• Services inflation excluding shelter has moved close to 4.0%, while labour-cost-driven inflation remains above 4.0%; the services inflation bill is around $40 billion, roughly four times its pre-Covid level.
• Addenda's simulation points to significant upcoming core reflation, with core and total inflation converging by the end of the first quarter of 2027; the Bank's references to resilient activity, solid consumption and upside inflation risks were interpreted as hawkish signals.

Takeaway: Addenda expects inflation to remain too high for the Bank to offset through an output gap, implying that Canadian rates may need to rise; the bond market had already reacted by flattening the Canadian yield curve during Governor Macklem's remarks.