The Federal Reserve raised its policy rate to a target range of 3.75 to 4.00 percent on September 16, its first increase in three years and a reversal of the three consecutive cuts that brought the rate down through late 2025. The Bank of Canada, meanwhile, has held its overnight rate at 2.25 percent since October 2025, unchanged through seven straight decisions including the September 2 announcement. The spread between the two policy rates now sits at 175 basis points, the widest gap since the two central banks began cutting in tandem at the start of 2025.
Both banks are responding to the same underlying shock: an oil price that has traded above 90 US dollars a barrel for most of September because of the continuing conflict in the Middle East. What differs is what each bank sees when it looks at that number.
The Mechanism Behind the Divergence
The Federal Open Market Committee cited persistent pressure in energy and consumer price measures as its justification for the hike, and the vote was unanimous. Chair Kevin Warsh, in his first hiking decision since taking over from Jerome Powell in May, is reading elevated oil prices as an inflation risk in an economy the Committee describes as expanding at a solid pace. The reasoning is straightforward: when the underlying economy has room to absorb higher input costs, a central bank worried about its 2 percent target moves to prevent those costs from passing into broader prices.
The Bank of Canada is working with a different starting point. Governor Tiff Macklem pointed to two forces holding the economy back rather than pushing it forward: the same Middle East conflict sustaining elevated energy prices, and the breakdown of Canada-US trade talks that has produced tariffs running as high as 50 percent in both directions. Canadian unemployment sat at 6.4 percent in July, and the Bank noted that demand for labour remains subdued with indicators pointing to continued excess supply. An economy with slack does not need the same inflation defence as one running at capacity. The Bank explicitly left the door open to cuts if the trade war weakens growth and employment further.
The Transmission to Fixed Mortgage Rates
The overnight rate is the lever the Bank of Canada controls directly, and it feeds straight into prime rate, variable mortgages and lines of credit. Fixed mortgage rates work through a different channel: they track Government of Canada bond yields, and those yields do not move in isolation from US Treasury yields. A hawkish Fed pulling US Treasury yields higher can drag Canadian bond yields with it even when the Bank of Canada itself does nothing, because Canadian and US government debt compete for the same pool of global fixed income capital.
That is the mechanism worth naming before the Bank of Canada next decision on October 28. A client watching only the Bank of Canada headline could reasonably expect fixed mortgage rates to sit still through the fourth quarter. The 175 basis point gap that just opened up says otherwise: the rate a fixed-rate renewal actually gets priced at can move on Washington news alone, independent of anything Ottawa decides.
The policy paths of the two central banks ran together through most of 2025, both cutting from restrictive territory toward a shared destination, before splitting apart entirely in September. The chart traces both rates from January 2025 through the September 16 Fed decision, the point where a year and a half of parallel movement became a genuine divergence.
The dashed line is the Bank of Canada overnight rate, the solid line is the Fed funds rate upper bound, both plotted at each central bank decision date. Source: Federal Reserve Board, Bank of Canada.