Markets Signal Three Potential Rate Hikes Ahead

Investors have increased their expectations that interest rates will rise in December and beyond, with rates potentially reaching three per cent. The central bank recently held its key interest rate at 2.25 per cent for the seventh consecutive time. Following the announcement, market expectations for a 25-basis-point increase in December rose to nearly 90 per cent, up from roughly 60 per cent the previous day.

Expectations for additional increases next year have also grown. Investors are now largely anticipating at least one 25-basis-point hike in January, while some are betting on as many as three increases by the middle of the year. However, some analysts believe these expectations may be too aggressive, arguing that while some tightening could eventually be justified by economic data, current market pricing may be overstating the likely pace of increases.

The outlook is being influenced by concerns that inflation could spread to other parts of the economy. Ongoing international conflicts and trade tensions have increased uncertainty, while new tariffs and counter-tariffs could put additional pressure on prices. Although some earlier expectations of rising inflation were considered premature, the combination of renewed inflation concerns and changes in expectations for U.S. interest rates has strengthened the case for higher Canadian rates.

Markets are also increasingly pricing in the possibility of higher interest rates in the United States. Expectations for a 25-basis-point increase at the next U.S. meeting have risen significantly, while investors are fully pricing in one increase by December and assigning a substantial probability to another. Changes in the U.S. interest-rate outlook are important for Canada because monetary policy in the two countries is closely connected, influencing expectations for the direction of Canadian rates.

A rate increase could also be considered at the central bank’s October meeting, when an updated economic and inflation report is scheduled to be released. The latest policy statement indicated that inflation remains too high, that risks to higher inflation have increased, and that the two per cent inflation target will remain a key focus for future decisions. Markets currently see just over a 40 per cent chance of an October increase, while forecasts suggest rates could reach 2.75 per cent by the end of the year and three per cent in 2027.