How the Bank of Canada rate hike could affect your finances, according to our experts

On Oct. 29, Economics reporter Mark Rendell, personal economics reporter Erica Alini and investment editor Darcy Keith answered questions on the Bank of Canada’s decision to increase its benchmark interest rate and what it means for the economy, consumers and the housing market.

The central bank’s governing council voted on Wednesday to raise the policy rate for the first time in three years with the goal of preventing high oil prices from becoming a sustained inflation problem.

Readers asked about whether this is the start of a monetary policy tightening cycle, what the hike spells for variable-rate mortgages and the impact of the U.S. Federal Reserve on Canadian markets. Here are some highlights from the Q&A.

The decision to hike

Is this the start of a tightening cycle? Where do you think the bank is headed into 2027?

Rendell: It’s seldom one-and-done for the BoC, so it seems safe to bet that there will be more rate hikes. The big question is how many. If you look at interest rate swap markets – which basically capture bond trader expectations for monetary policy – they’re pricing in three more quarter-point rate hikes by the end of 2027. So that would get you to a policy rate of 3.25 per cent.

If you talk to Bay Street analysts, some will tell you that this pricing is too aggressive, and it’s more likely to be one or two more quarter-point hikes over the next year. Truth is, no one knows. A lot depends on factors totally out of the BoC’s control: If oil prices fall and the U.S. hits Canada with new tariffs, it might be a short-lived rate hiking cycle. If oil prices stay high, and Ottawa and Washington make a deal to remove some tariffs, then the bank may want to tighten monetary policy more.

However, I don’t think we’re in for anything like the rate hike cycle we saw in 2022 and 2023. (Famous last words.) At that time the Canadian economy was overheating, people were flush with cash, interest rates were as low as they could possibly go, supply chains were totally wonky and you had a massive commodity shock following Russia’s invasion of Ukraine. By the time the bank started hiking, inflation was well and truly out of control. This time around, we’re mostly dealing with a fairly narrow energy shock.

BoC hikes rate to 2.5%, suggests more may be needed to contain oil-price shock

The U.S. Federal Reserve kept their interest rates on hold yesterday. Does the U.S. central bank’s decision impact Canadian markets and the economy? If so, in what ways?

Keith: What the Fed does absolutely impacts Canadian markets and our economy. Canadian bonds and equities largely take their direction from the U.S. day to day. The Canadian currency too is heavily influenced – much of its direction is dictated by the spread between Canadian and U.S. bond yields. Not surprisingly, the Canadian dollar rose as the BoC hiked and the U.S. held steady.

How will an interest rate increase while in a war in the Middle East and tariffs on imports and exports to this country help lower our inflation?

Alini: It’s certainly a different scenario from the previous rate-hike cycle, which started in March, 2022. In the run-up to that, we had a housing boom and consumers who had built up savings during the pandemic lockdowns and were eager to spend. Today, we have a languishing housing market, a weak job market and generally a rather fragile economy.

Usually, central bank interest rates are more effective at cooling off price growth when inflation is the result of an overheating economy rather than a supply-side shock like rising oil prices. That said, the pandemic-era inflation bout was also widely seen as a supply-side shock. A lot of the initial increase in prices was due to the supply-chain disruptions brought on by COVID-19.

Now it’s fuel prices that are driving up inflation. So far, businesses have not been nearly as quick to pass on those costs to consumers. But companies have seen their costs rise quite a bit because of higher energy prices. How long will they keep eating those costs?

This last rate hike was an attempt by the Bank of Canada to pre-empt high fuel costs turning into a broader run-up in consumer prices.

Was it necessary? I’ll leave that to economists (who are themselves quite divided on the matter).

How is throwing a wrench into our already vulnerable economy a rational response to inflation caused by disruptions to oil supply?

Rendell: That’s the (many) million-dollar question. As you rightly say, monetary policy is a bad tool for responding to a supply shock. Interest rates impact demand in Canada; they won’t help an oil tanker pass through the Strait of Hormuz. That’s why the central bank “looked through” the oil price shock for the past eight months or so. After a while, however, the BoC starts to become nervous that high oil prices will seep into other consumer prices – think transport costs going up, and companies passing those increased costs onto their customers.

So far there’s little evidence in the data that the oil price shock is spreading to other parts of the Consumer Price Index basket, but the bank is clearly worried that’s going to happen the longer oil prices remain high. Their new inflation forecast, for instance, sees headline inflation staying above 3 per cent for most of next year. Unfortunately (or maybe fortunately, depending on your view) the BoC has one and only one mandate: Keeping inflation running at 2 per cent. If that means hitting the rest of the economy with a hammer, it’s going to do so.

How big a deal is a 25-point increase, really? It just brings us back to where we were a year ago.

Rendell: One rate hike by itself isn’t a huge deal. At 2.5 per cent, the policy rate is still slightly stimulative. The Bank of Canada has this concept called the neutral range, which ranges from 2.25 per cent to 3.25 per cent. If the policy rate is in that band, it’s generally understood to neither stimulate nor hold back economic activity. Closer to the bottom, more stimulative; closer to the top, more restrictive. 2.75 is band in the middle, so we’re still a bit below that.

Now, all that said, what really matters about the hike is what it suggests about the direction of travel. If it’s the start of a hiking cycle – even a moderate one – then that matters more for borrowers and the economy more broadly.

How does this decision impact our ability to make a trade deal with the U.S., and the trade war in general?

Rendell: It probably won’t make much of a difference. Monetary policy operates separately from broader government decision-making on things like trade deals. That said, there is an interesting tie-in to the trade negotiation discussion. The BoC tends to cut interest rates when the economy is weak, and raise rates when it strengthens. If the trade negotiations for the U.S. were to take a turn for the worse, and Washington imposed new tariffs – which Trump has threatened to do come January – then that’s obviously bad for the Canadian economy, and the BoC might come to regret its rate hike this week.

If, however, Ottawa and Washington can reach some sort of deal that offers relief to tariff-hit sectors, then that’s positive for the Canadian growth story, and might shore up the bank’s thinking around the need for higher interest rates.

Why does the BoC consider inflation to be a bad thing?

Rendell: At the heart of it is the issue of affordability, which is adjacent to, but slightly different from what the BoC spends its time thinking about (inflation). If prices are rising and wages are not, people are going to get squeezed. The BoC does think about wages, but really more as they relate to inflation: i.e. if wages are rising quickly, this can feed through into the rate of inflation, as the companies raise prices to offset their labour costs.

But stepping back to the big question: Why does the BoC think inflation is bad? Ultimately it’s because a stable currency (which the BoC calls 2 per cent annual inflation) makes it easier for people to make financial decisions. It’s a lot easier for households and companies to plan if they know how far their budget will go. If prices and wages were both rising at 10 per cent a year, in some ways it wouldn’t matter from an affordability perspective. But it could make it harder to make economic decisions. Ultimately, the BoC thinks price stability is an economic good in itself.

The effect on the housing market

What kind of impact will this have on our currently-slow housing market?

Alini: It will probably slow an already slumping market. Rising rates will likely slow sales and put downward pressure on prices. More on this from my colleague Rachelle Younglai here.

Looking forward to 2027, are variable mortgages still a better choice than fixed mortgages?

Alini: Variable rates are still considerably lower than fixed rates. Are they a better choice? That depends, among other things, on how many more rate hikes are in store in the next few months and, beyond that, the path of rates over the mortgage term you choose. (If you choose a five-year term, lots can happen in five years – even cuts, perhaps!) It is still possible that variable will turn out to be the cheaper choice. But, of course, there are no guarantees. And anyone going variable should feel very comfortable about their ability to absorb several more rate hikes.

Keith: This ultimately comes down to one’s view of whether the economy will soften in the months ahead (in which case variable would look good right now) or whether inflation will continue to accelerate (in which case, likely go fixed). Bond markets right now are pricing in 75 basis points more of BoC hiking over the next 12 months. If that comes true, variable rates will go up to the same degree. So that’s something to think about: is the variable rate being offered to me today 75 basis points below a longer-term fixed rate? But markets and economists can quickly change their views. So know that there’s always a risk you won’t be happy with your choice.

Investing and personal finance

With the interest rate hike, what is the optimal balance between paying down debt, holding cash and investing in long term growth assets?

Keith: This depends on the specifics. Pay down debt for sure if you got credit card debt that has high interest rates attached to them. Hold cash? Having emergency funds is always a good idea. Long-term growth assets? Absolutely if you won’t need to touch your investments for a good five to 10 years.

Alini: Here are a few considerations: If you have large balances on variable-rate loans or credit products, it’s a good time to review those and see if you should accelerate payments. Lines of credit, which have variable rates, are a prime candidate for scrutiny right now. If you have a big balance on a home equity line of credit (HELOC), now may be a good time to attack it more aggressively. Ditto if you have a personal line of credit with a high interest rate. Another one is auto loans, which sometimes have variable rates.

Holding cash: We could see some banks – especially online-only banks – increase their savings account interest rates in response to central bank hikes. If you have a lot of money sitting in cash, it’s a good idea to monitor financial products comparison sites and keep an eye out with these kinds of adjustments.

The same thing holds for guaranteed investment certificates. GIC rates are linked to bond yields, more than the Bank of Canada policy rate. But because bond markets anticipate central bank moves, and yields have been climbing for months, GIC rates are back to being pretty attractive. It’s a good time to shop around.

Interest rates are rising – here’s how savings accounts and GICs are keeping up

On the flip side, is now a good time to invest in GICs or other investment vehicles?

Keith: GICs are largely priced off of what the bond market is doing, although there are other variables, including supply and demand of these products at any one time and competition in the industry. Bond yields rose sharply in early to mid September as oil prices rallied, and indeed, it didn’t take long for GIC rates to respond. I personally bought some longer-term GICs near the 4 per cent level at that time. That’s not as high as the 5-per-cent payouts we saw during the inflation surge that followed COVID-19, but historically quite decent.

Here’s a way to do a bit of sleuthing to figure out where GIC rates may be going. Decide what type of term you are interested in, and look at the equivalent government of Canada bond yield. For instance, for the five-year bond yield, you can monitor it here in real time.

What about general savings accounts? These savings rates are heavily influenced by Bank of Canada policy moves, even though most financial institutions rarely pass along a full quarter point hike by the Bank of Canada. As of today, bond traders are pricing in 54-per-cent odds of another BoC rate hike this December, and are fully pricing in another quarter point hike by January. They are betting on three quarter-point hikes over the next year.

Those bets in credit markets constantly change. But bond markets are full of a lot of very intelligent people, and they’re current thinking is more BoC hiking is on the way. Savings accounts should benefit.

This Q&A has been edited and condensed.