TD Securities forecasts the Bank of Canada will keep the Overnight Rate at 2.25% through 2026. It projects a return to a 2.75% neutral rate in early 2027, via 25 basis point hikes in January and March.
The policy statement carried a slightly dovish tone and said weaker trade conditions could lead to further rate cuts. It also noted that rising geopolitical risks could lead to consecutive increases, which drove a repricing at the front end of markets.
Oil Prices And Inflation Shock
Higher oil prices linked to US–Iran tensions and threats to global crude supply are described as an inflation shock. The forecast assumes policymakers can wait for more clarity on geopolitical risks and how they feed into domestic CPI.
Inflation is projected to peak at about 3% in Q2, above the Bank’s April Monetary Policy Report projections. The view also assumes inflation expectations remain well anchored, inflation breadth is lower, and core inflation momentum stays muted.
The forecast was revised to two hikes to 2.75% in early 2027, down from three. The article was produced using an AI tool and reviewed by an editor.
We expect the Bank of Canada to maintain its overnight rate at 2.25% through the remainder of 2026. Current market pricing, reflected in Banker’s Acceptance futures, suggests a probability of at least one rate hike by year-end. This presents an opportunity, as we see the Bank remaining patient despite recent market jitters.
Implications For Front End Pricing
Rising geopolitical tensions have pushed WTI crude oil prices above $95 a barrel, creating a significant inflation shock. While the latest headline CPI for March came in at 2.9%, we note that core measures like CPI-trim have remained stable around 2.1%. This suggests the underlying price pressure is not widespread enough to force the Bank’s hand.
This allows the Bank to look through the temporary spike in headline inflation, a stance consistent with their actions in the second half of 2025 when they first paused this cycle. Inflation expectations remain well-anchored, giving policymakers the flexibility to wait for more clarity. Therefore, traders should consider that the bar for a rate hike in 2026 is much higher than the market currently implies.
The divergence between our view and market pricing suggests the front-end of the Canadian yield curve is too steep. Options strategies that benefit from low volatility and a stable overnight rate, such as selling straddles on short-term interest rate futures, could be advantageous. This position anticipates that the Bank will not deliver the hawkish surprise the market has priced in.
We see the return to a neutral rate as a story for early 2027, with two gradual 25 basis point hikes then. This is a slower path to normalization than we previously anticipated just a few months ago. In the near term, this reinforces the view that the Bank will prioritize stability over reacting to volatile energy prices.
