The Bank of Canada raised its policy rate by 25 basis points to 2.50% on October 28, the first increase since July 2023. Statistics Canada reported headline inflation of 3.1% for September, so the new rate still sits 0.6 percentage points below it. Behavioural economics predicts that the nominal figure will carry the story anyway.
The reason is a habit economists call money illusion: people judge rates, prices and wages by their face value rather than by what they buy after inflation. The October decision is a clean test of it.
Headline inflation has exceeded the policy rate in every month since March 2026, a gap the October increase narrows from 0.85 points to 0.6 but does not close.
Values are year-over-year headline CPI and the month-end policy rate. The series ends in September and does not include the October 28 increase to 2.50%.
What the Hike Actually Changed
The Bank held at 2.25% for seven straight meetings before this one, and Governing Council discussed holding again. Governor Tiff Macklem said there could be a need to raise the rate further, but that Council would proceed carefully and decide one meeting at a time. He described the rate as still low enough that it does not restrain growth, at the low end of the neutral range.
The October Monetary Policy Report explains the urgency. The Bank now expects inflation to average 2.9% in 2026 and 3.1% in 2027, up 0.4 and 1.1 percentage points from its earlier projections. Energy is the main driver: September CPI showed energy prices up 19.0% from a year earlier, with gasoline up 27.8%.
Growth is expected to hold up for now. Second-quarter output rose at a 3.3% annualized pace, and the Bank projects 2.0% in the third quarter and 0.8% in the fourth. Reuters reported that the two-year government bond yield reached a two-year high after the decision and that the Canadian dollar firmed to about 71 US cents.
Why the Nominal Number Wins
Shafir, Diamond and Tversky showed in a 1997 paper in the Quarterly Journal of Economics that people think in nominal rather than real terms. Irving Fisher had described the same tendency in his 1928 book The Money Illusion. A 2021 replication by Ziano and colleagues in the Journal of Economic Psychology, using 604 participants, reproduced several of the original problems.
Prospect theory, set out by Kahneman and Tversky in 1979, adds a second force. Losses loom larger than gains, and a variable-rate payment that rises by a visible dollar amount registers as a loss. Erosion of purchasing power from 3.1% inflation arrives as a diffuse drift across hundreds of small purchases, so it rarely registers at all.
The result is an asymmetry. A hike to 2.50% looks like a decisive tightening because the figure is itemized on a statement. A real policy rate of roughly negative 0.6% looks like nothing, because no statement prints it.
The Core Measures Complicate the Story
Headline inflation is not the only reading. The core gauges the Bank watches most closely were softer in September, with CPI-trim at 1.8%, CPI-median at 1.9% and CPI-common at 2.4%. Against the first two, a 2.50% policy rate sits above core inflation rather than below it.
That split gives anchoring a second job. Tversky and Kahneman showed in a 1974 paper in Science that people lean on the first number they encounter. Households anchored on the 3.1% headline will tend to judge the Bank as behind the curve, while those anchored on the core measures will tend to judge it as already restrictive.
Local experience adds noise. Ontario CPI was 2.5% in September and Toronto was 2.1%, while Prince Edward Island reached 5.7% and Nova Scotia 5.6%. A household in Toronto can reasonably feel that the national inflation figure belongs to someone else.
Markets are not waiting to settle the argument. Charles St-Arnaud of Servus said he would be surprised if there was no increase in December, and the next decision comes on December 9. Three dates will test the narrative before then: the federal budget on November 5, the October CPI release on November 16, and the Bank decision itself.