Trade uncertainties and slowing immigration growth are expected to limit how high the Bank of Canada raises its benchmark interest rate in the coming year, according to a report released Wednesday by Capital Economics. The analysis suggests that challenges facing Canada’s economic growth will restrain inflationary pressures, reducing the need for aggressive monetary tightening.
The Bank of Canada has maintained its key policy rate at 2.25 percent since October 2025, as it monitors the effects of ongoing U.S. trade disputes and geopolitical tensions, including the conflict in Iran. The central bank is set to provide updated economic and inflation forecasts at its next policy announcement scheduled for Oct. 28.
Market speculation has increasingly leaned toward earlier rate hikes amid concerns that rising oil prices could fuel persistent inflation. However, the Bank of Canada has indicated limited signs so far that higher gasoline prices are driving broader increases across the consumer price basket. Policymakers have nonetheless signaled readiness to raise rates if inflation escalates further.
Capital Economics projects the central bank will implement two quarter-point rate increases next year, raising the policy rate to 2.75 percent. This level would position borrowing costs at the midpoint where they neither accelerate nor restrict economic growth. This forecast of a cumulative 0.50 percentage point hike contrasts with market expectations of about 1.25 percentage points in increases before the end of 2027.
The report highlights several factors expected to dampen inflationary pressures, including persistent trade uncertainty—especially relating to U.S. tariffs—and weaker population growth. Recent tariff measures under U.S. President Donald Trump’s Section 338 and Canadian product bans are unlikely to cause broad economic disruptions, but the resurgence of trade tensions is expected to delay renewed negotiations over the Canada-U.S.-Mexico trade agreement.
Revised data from Statistics Canada indicated that Canada’s population did not experience the previously reported annual decline. Capital Economics suggests this could prompt the federal government to further tighten immigration levels in an effort to meet population targets. Such a move may weigh on household consumption and potentially stall a recovery in the housing market, though the unemployment rate could decline more rapidly than anticipated.
A subdued labour market is also contributing to restrained wage-driven inflation. Statistics Canada reported on Tuesday that economic growth was flat in July but likely picked up in August, reflecting volatility linked to tariff disruptions and geopolitical developments.
Looking ahead, Capital Economics forecasts real GDP growth of 1.5 percent in 2027, normalizing to around 2 percent in 2028 as infrastructure and artificial intelligence projects gain momentum. While recent enhancements to federal tax incentives aimed at encouraging business investment have improved near-term growth prospects, the report notes that significant progress toward Prime Minister Mark Carney’s ambitious infrastructure agenda is unlikely before late 2027.