An interest rate hike in 2026 is unlikely, RBC says

RBC economist Abbey Xu noted that Canadian inflation edged higher in September, driven largely by rising energy prices, although there is limited evidence that those costs are spreading broadly through the economy.

In her latest inflation report, Xu pointed out that Canada’s annual inflation rate rose to 3.1% in September from 3.0% in August, below consensus expectations of 3.2%. Headline consumer prices increased 0.4% month-over-month on a seasonally adjusted basis. Energy prices were 19% higher than a year earlier, accelerating from 15.4% in August. Gasoline prices rose 27.8%, contributing 1.1 percentage points to headline inflation.

Xu said higher fuel costs are increasingly affecting transportation prices, particularly airfares, which rose 19.4% year-over-year compared with 15% in August. However, inflation outside food and energy remained relatively contained at 2.1%.

Food inflation eased to 2.2% from 2.8% in August. Grocery prices rose 1.7%, their slowest annual pace since May 2024, while restaurant prices increased 3.1%. The Bank of Canada’s preferred CPI-trim and CPI-median measures were 1.8% and 1.9%, respectively.

Xu said inflation pressures broadened somewhat in September, with 47.8% of CPI components rising faster than 3%, up from 25.9% in August. On a three-month annualized basis, the average of CPI-trim and CPI-median increased to 2.6% from 2.3%.

Shelter inflation rose to 1.8% from 1.5%, partly reflecting faster price growth in homeowners’ home and mortgage insurance, maintenance and repairs.

Xu argued that the Bank of Canada faces a difficult balance between a gradually improving but still soft economy and the risk that higher oil prices lead to more persistent inflation.

Employment declined in both August and September, while the unemployment rate remained around 6.5%.

Bank of Canada Governor Tiff Macklem recently warned that the risk of inflation becoming broader and more persistent has increased, making it harder for policymakers to look past higher energy prices.

Xu said producer-price pressures have widened, but sustained increases would need to pass through several stages of production before affecting consumer prices more broadly.

RBC’s base-case forecast calls for the Bank of Canada to hold its overnight rate unchanged through the remainder of 2026 before gradually raising rates in 2027.

Xu said weaker labour-market conditions and higher fixed borrowing costs give policymakers room to remain patient.

However, she cautioned that the Bank’s increasingly urgent language raises the possibility of a preemptive rate increase even before broader inflation pressures become evident in consumer prices.

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