On Monday (October 26) during Asian trading hours, the US dollar rose against the Canadian dollar before retreating, currently trading above 1.4010. The exchange rate is in its lowest range since September 22. Market expectations for a Bank of Canada rate hike this week continue to rise: the market is pricing in an approximately 81% probability that the Bank of Canada will raise rates by 25 basis points to 2.50% on Wednesday, its first action in a year, after Macklem hinted at an upward revision to its inflation forecast.

Key conclusion: The first interest rate hike in a year is imminent, but it is not without controversy.

The Bank of Canada is expected to raise interest rates on Wednesday, its first such move in a year. The market is pricing in an 81% probability of a 25 basis point increase to 2.50%, but some economists still believe this move lacks justification. The speed of this shift in expectations is remarkable. A survey conducted by financial media from October 21st to 23rd showed that 19 out of 34 economists expected a rate hike this week, with most also predicting another hike to 2.75% by the end of March 2027. This is a stark reversal from the previous survey, where 80% of respondents expected the central bank to maintain the rate at 2.25% until the end of 2026.

Catalyst for expected reversal: Macklem hints at upward revision of inflation forecasts

The catalyst came from Governor Tiff Macklem. He told reporters that the central bank's quarterly inflation forecast, to be released alongside its policy decision on Wednesday, might be revised upward. The market interpreted these comments as a signal of impending tightening. According to media reports, the futures market's pricing in an October rate hike jumped from about 30% before his speech to about three-quarters. The following week, many economists changed their forecasts from "maintain" to "rate hike."

Those who support raising interest rates: Survey data and rising inflation expectations

HSBC analysts point out that recent survey data has begun to signal an interest rate hike, particularly a significant rebound in long-term consumer inflation expectations. Although hard data such as employment and retail sales are generally weak, the rise in expectations indicates that businesses and households are increasingly aware of price pressures. Analysts believe that if inflation expectations continue to deviate from the central bank's target range, even with current weak economic momentum, the central bank may still choose to tighten monetary policy first to prevent self-fulfilling prophecies. Survey data often precedes actual price performance, therefore the market sees this as a key factor supporting a near-term interest rate hike.

Those opposing interest rate hikes argue that the inflation outlook is narrow and the short-term prospects are unclear.

Not all institutions share the market's unwavering assessment of an interest rate hike. TD Securities analysts emphasize that current inflation is mainly concentrated in a few sectors such as energy, with overall inflation remaining narrow, and significant uncertainty surrounding the short-term economic outlook. Some further point out that energy-driven price increases are unlikely to quickly transmit to core inflation; only broader price pressures will prompt the central bank to truly shift to tightening. Furthermore, a weakening labor market earlier in the fall also prompted the market to postpone its expectations for an interest rate hike until December. These factors collectively constitute arguments against immediate action.

Market reaction logic: The decision itself is secondary; reports and guidelines are key.

The interest rate decision and accompanying monetary policy report will be released at 21:45 Beijing time on Wednesday. Since the rate hike itself has largely been priced in by the market, the real drivers of the foreign exchange and bond market reactions will be the central bank's updated growth and inflation forecasts, as well as its guidance on further tightening. If the report shows a significant increase in inflation risks, or hints at further room for rate hikes, the market may further strengthen its tightening expectations; conversely, profit-taking may occur. The August GDP data released on Friday will be an early litmus test for this outlook, potentially exacerbating or mitigating current pricing volatility.

Summarize

The Bank of Canada is highly likely to raise interest rates by 25 basis points to 2.50% on Wednesday, the first increase in a year, with the market pricing in an 81% probability. Macklem's hints at an upward revision to inflation forecasts acted as a catalyst for this reversal of expectations. Media surveys and HSBC both favored a rate hike, but TD Securities remained skeptical due to the narrow scope of inflation. With the rate hike nearly fully priced in, the Canadian dollar's performance will depend on the forecast adjustments and forward guidance in the monetary policy report: signals of further tightening will support the Canadian dollar, while the "one rate hike, wait and see" approach may dampen expectations for further rate hikes. Oil prices and Friday's GDP data will be key variables going forward. (USD/CAD daily chart, source: EasyForex) At 8:25 Beijing time, USD/CAD was trading at 1.4012/13.