Canada's Inflation Test: Insurance, Not a Cycle

In September, three of the four major developed market central banks raised rates. The European Central Bank, the Federal Reserve and the Bank of Japan have all tightened, and the Bank of England looks likely to follow in November. On episode 45 of BMO Global Asset Management's Open Outcry podcast, host Bipan Rai describes the moves as "largely insurance based¹, to ensure that the second-round effects of the supply shock is contained." He asks Desjardins' Royce Mendes how much of that insurance Canada actually needs.

The Hormuz Problem

Oil sets the scene. WTI trades near $94 to $95, down from last week's $106 high. Rai cautions that the pullback rests on diplomatic channels opening rather than any truce, which makes comfort "tenuous at best." The Bank of Canada held at 2.25% in September but sounded hawkish, and Governor Macklem reinforced that tone in Halifax.

Mendes is candid about what monetary policy cannot do. "The Bank of Canada's interest rate tool cannot reopen the Strait of Hormuz, cannot repair damaged refining capacity around the world," he says. "Unfortunately, the Bank of Canada has been given a single remit, and that is to keep inflation at 2%." With headline inflation near 3%, he stresses that "headline inflation is the target." In this environment, he argues, "the contemporaneous core inflation readings are less useful in this context than just the absolute level of oil prices." Desjardins still expects liftoff in January. If energy stays elevated, though, Mendes says the October decision "is very much live."

Slack Versus Pass-Through

Rai raises the obvious objection: an economy with slack should absorb price pressure without help from the central bank. Mendes acknowledges that the governing council is divided on this, but he leans toward caution. "I talk to a lot of companies across this country, and it does feel like a lot of them have reached the limit of how much they can absorb in terms of increased costs from higher energy prices," he says. On whether the slack is enough, his answer is plain: "we don't know if it's enough."

Trade makes the call harder. If the latest U.S. tariffs remain in place, Mendes warns, "the economy could be limping into the fourth quarter and maybe even limping into the new year." Desjardins' base case is a partial rollback. "It doesn't assume that we go back to full free trade as we had pre-2025," he says. He also notes that while the U.S. and Mexico update USMCA, "Canada's not really involved in those talks."

Capital Is Not the Constraint

On last week's investment summit, Rai says he doesn't think "access to financing is a problem for Canada," adding that "it's really getting that money and putting it to work." Mendes agrees and points to "a clear shift in foreign demand for Canadian assets" since the 2024 U.S. election. He calls accelerated depreciation for capital spending a change that "makes total sense." Even so, he pencils in only a tenth or two of a percentage point of added investment in 2027. To be fair, he notes, "we have seen big announcements before" that did "not really materialize into shovels in the ground."

The Market Is Ahead of Itself

Overnight index swaps price 50 basis points of hikes by January and 120 by the end of 2027. "Based on everything we've talked about, that feels a bit ridiculous," Rai says. Mendes can describe a path to that outcome, through high pass-through and energy-driven investment, but he gives it a low probability. "The market's probably a couple of rate hikes ahead of where I see things in a base case," he says, adding, "I don't think this is the beginning of a full-blown tightening cycle." The positioning consequence follows directly: "I think there's value in the front end of the curve in government of Canada."

No Escape at the Long End

The long end tells a different story. U.S. 10-year yields briefly topped 5%, and Canadian 10-year yields sit at 3.82%. Mendes adds a fourth pressure to Rai's list of supply, credibility and oil: a changing buyer base. He explains that "less and less of the debt" is going to price-insensitive holders such as central bank reserve managers. Issuance as a share of global GDP is nearing levels usually seen in a crisis, yet "there's no crisis right now." Canada's fiscal position helps, and "Canada is more resilient in this case to the global rise in bond yields." Still, he flags a possible near-term rally in which Canada could underperform.

The Loonie's Longer Game

USD/CAD is trading above 1.40. In the near term the currency follows oil and risk sentiment. Over the medium term Mendes is constructive, observing that "we've sort of lagged on AI adoption," which leaves room for a productivity catch-up. He calls a level above 1.40 "a good entry point."

The Verdict

The message is measured. Canada faces a real inflation test, but it does not call for a full tightening cycle. Two, perhaps three, insurance hikes may be warranted; five is a stretch. When the facts change, the positioning changes too. For now, the facts favour the front end of the Canadian curve and a patient view on the loonie.

5 Key Takeaways for Advisors and Investors

1. Headline inflation, not core, drives the Bank of Canada now. With headline CPI near 3% and a single 2% mandate, the level of oil and diesel prices matters more than slicing core data. October is live; January is the base case.
2. Expect insurance hikes, not a new cycle. Mendes sees two, at most three, hikes. That makes market pricing of roughly 120 basis points by the end of 2027 look a couple of hikes too aggressive.
3. The front end of the Canada curve offers value. If the market is overpricing the tightening path, short-dated Government of Canada bonds are the clearest opportunity.
4. Long-duration risk is global and structural. Heavy issuance, credibility concerns and a shift toward price-sensitive buyers mean Canadian long bonds will follow any global sell-off. Canada's fiscal strength should cushion it on a relative basis, though a near-term relief rally is possible.
5. Use loonie weakness as an entry point. Near-term CAD tracks oil and risk sentiment, but capital inflows, business investment incentives and an AI productivity catch-up support a medium-term bullish view above 1.40.

Footnote:

1 Rai, Bipan, host. "Canada's Inflation Test: How Many Hikes Are Enough?" Featuring Royce Mendes. The Open Outcry Podcast, episode 45, BMO Global Asset Management, 22 Sept. 2026.