By Michael O’Neill

If you went trick-or-treating at Bank of Canada Governor Tiff Macklem’s house today, you got a rock. No chocolate, no Sour Patch Kids, no Skittles and absolutely no tasty delights.

BoC Governing Council may have dressed in Halloween costumes for today’s meeting. If so, Mr. Macklem, dressed as the Dark Lord Sauron, must have gazed into the darkest depths of his crystal ball, which told him to raise interest rates. He did.

The BoC hiked its policy rate 25 basis points to 2.5%, its first hike since July 2023, to head off an inflation wave that has not yet arrived.

Core inflation is close to 2%. Inflation excluding gasoline is 2.2%. The Bank’s own measures of inflation show nothing out of the ordinary. The case for tightening rests almost entirely on what Governing Council believes will happen next. It’s a feeling, not a fact.

That would be reassuring if the Bank had a habit of seeing the future clearly. It doesn’t.

Garbage In, Garbage Out

In July, the Bank forecast 2027 inflation at 2.0%. Today it says 3.1%, a full percentage point of revision in a single quarter. July’s call for the third quarter of this year was 2.5%. Inflation came in at 3.0%. The fourth-quarter estimate has leapt from 2.4% to 3.4%.

The culprit is oil, and the oil assumptions are worse. The January Report pencilled in Brent at roughly US$60 a barrel. The front-month contract now trades near US$115. Nobody expects a central bank to forecast wars. But a central bank that can’t forecast wars should be careful about hiking on the assumption that this one will drag on.

A Decade of Misses

This is not a one-off. In the years after the 2008 financial crisis, inflation ran below target most of the time while the Bank kept forecasting a return to 2% that never quite arrived.

Then came Covid. In April 2021, the Bank projected inflation of 1.9% for 2022. Through the rest of that year it insisted the price surge was transitory, later amended to “transitory but not short-lived.” Inflation hit 8.1% in June 2022, the highest since 1983, and the Bank spent the next year and a half slamming on the brakes, including a full-point hike that was the largest since 1998.

If Hunches were Lunches, We’d Have a Banquet

So what tipped the scales? Macklem said “past experience and Bank surveys” point to rising cost pass-through. One of those surveys is a panel of 35 consumer-facing firms. That’s not a sample; it’s a dinner party. And past experience means the pandemic, the episode the Bank got spectacularly wrong. Governing Council is fighting the latest war, using the memory of its worst forecast as the guidepost.

Macklem also acknowledged uncertainty about how long energy prices will stay high and how much of those costs will seep into consumer prices. The reality is that the BoC has raised rates to guard against a spillover it says it can’t measure, from an energy shock it says it can’t forecast.

But It’s Different This Time

The Bank’s latest inflation forecast was built using Prima, its new economic model, which went live in September. Given the stakes, a longer testing period might have been prudent before entrusting it with decisions that affect every Canadian borrower.

A Bank staff paper concedes that, tested on past data, Prima forecasts GDP and inflation about as accurately as a simple statistical benchmark. Run the model back over 2026, and its cost channels suggest inflation should have been noticeably higher than it actually was.

The MPR files the difference under “residual.” The forecast assumes that shortfall in inflation will eventually be made up, as businesses pass on costs they have absorbed rather than take the hit themselves. Or perhaps weak demand means they can’t.

Then there is the oil forecast holding it all up. Bank research published this month found the best economic model predicts the direction of oil prices “little better than a coin toss.”

All Hiked Up and Nowhere to Go

The Bank is now reacting to its forecasts rather than its data, and its forecasts change every three months. If oil falls faster than the futures curve implies, inflation will cool without Ottawa’s help and the Bank will have tightened into a slowdown. “One meeting at a time” is the exit door, and the track record says the next forecast revision will arrive before the next hike.

The Loonie is unlikely to get much mileage from the BoC decision. The hike was largely priced in, the guidance promised nothing more, and with the Fed expected to stand pat, the gap between Canadian and US two-year yields has little reason to shift before December. USDCAD should settle into a 1.3880-1.4180 range, with the 200-day moving average anchoring the downside.

Macklem’s crystal ball has been cloudy for a decade. It still is.