Bond Markets Push Bank of Canada Toward Rate Hike

The Bank of Canada may face pressure to raise interest rates at least once before the end of the year, according to KPMG Canada. Ali Jaffery, chief economist at KPMG Canada, predicts a 25-basis-point hike at the December 9 meeting, bringing the benchmark lending rate to 2.5%. This shift comes as bond markets demand greater credibility from policymakers regarding inflation and fiscal sustainability.

Jaffery argues that bond markets are pushing for policy credibility amid global concerns about inflation and debt crises in the U.S., France, and Japan. He warns that the bond market's indiscriminate approach could impose a premium on Canada, despite its relatively stable fiscal and monetary policies. The Government of Canada's five-year bond yield has surged to nearly 4%, up almost 100 basis points from a year ago, with a significant portion of the increase occurring last month.

The rise in Canadian bond yields is partly attributed to Bank of Canada governor Tiff Macklem's recent hawkish tone. Jaffery traces the yield increase to Macklem's September 2 press conference, where he emphasized the threat of inflation from high energy prices over concerns about U.S. tariffs. Additionally, the devaluation of the Canadian dollar due to the widening interest rate spread with the U.S. could accelerate inflation, making it harder for the Bank of Canada to resist U.S. rate hikes.

Long-term bond yields continue to rise despite weaker U.S. economic data, which may deter the Federal Reserve from hiking rates in October. Karl Schamotta, chief market strategist at Corpay Inc., notes that yields are now tracking oil prices more closely than inflation.