Money markets raised the probability of a Bank of Canada rate increase on Friday, assigning a better-than-20% chance that the central bank will tighten policy next month as the conflict involving Iran shows no sign of abating and oil prices climb.
The move was driven largely by activity in the overnight interest rate swap market, which had earlier priced in only a barely 4% chance of an April hike. LSEG data show the market now points to a cumulative 75 basis points of increases in the BoC's benchmark policy rate by year-end. Just one day earlier, markets were signalling only a single 25 basis point rise pencilled in for December.
Market expectations have shifted sharply since late February. Before U.S.-Israeli strikes on Iran began on February 28, traders had been tilting toward a mid-year rate cut. The subsequent escalation has spread through the Gulf and forced the closure of the Strait of Hormuz, a waterway responsible for almost a fifth of global oil trade.
That disruption has been accompanied by a steep jump in liquefied natural gas prices and concerns about potential shortages of fertilizers. Those developments are reviving upside risks to global inflation and heightening fears of recession, factors that market participants say have prompted the re-pricing of the Bank of Canada outlook.
The Bank of Canada has maintained its policy rate at 2.25% since October. Governor Tiff Macklem said this week that the bank has some time to observe how the Iran conflict affects Canada’s economy but warned that if energy prices remain elevated, the central bank would "not let their effects broaden and become persistent inflation."
At the same time, a number of economists cautioned that raising interest rates while the Canadian economy shows signs of weakness could harm businesses and households. Those economists contend the BoC should remain on the sidelines for the rest of 2026 to avoid exacerbating domestic economic strain.
Contextual note: Markets referenced above are predominantly reflecting pricing in the overnight interest rate swap market and the shifts in expectations are based on LSEG data as reported.