Bank of Canada raises interest rates for the first time in more than three years, key rate now 2.5 percent

Canada's central bank, the Bank of Canada, has raised its key interest rate for the first time in more than three years, as soaring energy prices pushed up inflation.

On Wednesday the bank increased the key rate by a quarter point to 2.5 percent. The hike was widely expected.

At the same time, the bank ramped up its inflation forecast for 2027 to 3.1 percent from the 2 percent it had predicted in July. Growth this year is set to be 1 percent, higher than the 0.7 percent seen in July.

Bank governor Tiff Macklem said: 'With the outlook for inflation substantially higher and the economy showing resilience, an increase in the policy rate is needed to reduce the risk that elevated energy prices could spill over and become generalised inflation.'

He added: 'There could be a need to increase the policy rate further, but given uncertainties, we will proceed carefully.'

The annual inflation rate hit 3.2 percent in September, above the bank's 1 to 3 percent target range, and was driven almost solely by higher energy and energy-related transportation costs.

Macklem said inflation was expected to end the year at 3.5 percent and stay at around 3 percent for most of 2027, before returning close to the 2 percent target by the middle of 2028.

He said the Governing Council agreed that risks to inflation had increased and there was less scope for monetary accommodation.

Andrew Grantham, senior economist at CIBC Capital Markets, however, does not expect core measures of inflation to accelerate as much as the bank fears, particularly if global energy prices ease a little, and as a result does not think the policy rate will need to move above 2.75 percent.

Economists who opposed a rise said core inflation, which strips out the cost of volatile items, is still hovering at about 2 percent. They also say a rate hike could impede modest economic recovery, given US trade tensions and a weak job market.

Macklem said new US tariffs would slow the economy in the fourth quarter, but expressed confidence that growth should pick up again in 2027 as consumer spending continues, exports pick up and business investment strengthens.

After robust annualised growth of 3.3 percent in the second quarter, the economy is likely to slow to 2 percent in the third quarter and further down to 0.8 percent in the fourth quarter, the bank's new monetary policy report projected. However, it upgraded its GDP forecast for both 2027 and 2028 to 2 percent from 1.8 percent. Macklem said this additional growth would help absorb the slack in the economy. The bank's next rate decision is on December 9.