The Bank of Canada is widely anticipated to raise its benchmark interest rate for the first time in three years during a policy decision expected on Wednesday, amid persistently high oil prices and concerns about inflation. The move would mark a shift after the central bank held its policy rate steady at 2.25 percent since October last year, balancing the potential inflationary impact of rising energy costs against economic risks from ongoing trade tensions and global uncertainty.

Governor Tiff Macklem has recently signaled growing concern about the inflationary risks from elevated oil prices, which have surged partly due to tensions in the Middle East, including the closure of the Strait of Hormuz to much tanker traffic amid conflict involving the United States and Iran. Since Macklem’s remarks at the International Monetary Fund meeting in mid-October, financial markets have sharply increased the likelihood they assign to a rate hike, with odds rising from around 35 percent to nearly 90 percent.

Oil prices continue to climb, with Brent crude recently reaching a six-month peak near US$116 per barrel and West Texas Intermediate trading above US$100. This jump has contributed to a rise in consumer prices, with the headline inflation rate reaching 3.1 percent in September. However, much of the increase is tied directly to gasoline prices, which rose 6.1 percent monthly. Excluding energy, inflation showed signs of easing, with core measures around 1.8 to 1.9 percent.

Some economists caution that the data do not yet provide a clear mandate for tightening monetary policy. Jeremy Kronick, head of monetary policy at the C.D. Howe Institute, noted that the recent inflation increase appears driven primarily by energy prices rather than broad-based consumer price pressures. He suggested that markets may be reacting largely to Macklem’s forward-looking statements rather than current economic conditions. Nevertheless, attention to inflation expectations is also a key factor. Recent surveys indicate a notable rise in long-term inflation expectations among consumers and businesses, which policymakers view as a risk because such expectations can influence actual inflation outcomes.

Economic challenges beyond inflation persist. The housing market remains weak, unemployment levels are elevated, and threats of additional U.S. tariffs on Canadian auto exports loom, complicating the Bank’s decision-making environment. Some economists argue that a rate hike could be appropriate if energy prices remain high and trade disputes are resolved favorably, but warn it might prove premature if conditions shift.

Looking ahead, market participants anticipate multiple rate increases over the next year, with projections suggesting the policy rate could rise to 3.25 percent by the end of 2024. Canadian bond yields have already moved higher in recent months, reflecting expectations of eventual tightening by the Bank of Canada and shifts in U.S. monetary policy, which recently paused its own rate hikes before the upcoming U.S. midterm elections.

Overall, the Bank of Canada faces a delicate balance between containing inflation risks linked to soaring oil prices and shielding a still-challenged Canadian economy from premature tightening. The rate decision this week will be closely watched for signals on how the central bank intends to navigate these competing pressures in the months ahead.