1Q26_ Quarterly Outlook Report_Final_EN - Flipbook - Page 139
T H E P LUMB LI N E | A RETU RN TO F I RS T PRI N CI PL ES
Monetary policy expectations
6%
4%
2%
0%
-2%
2022
2023
Canada
2024
U.S.
2025
Eurozone
2026
U.K.
Japan
Sources: Bloomberg Finance L.P., Scotia Wealth Management | Dashed lines represent market expectations as at December 31, 2025.
The Bank of Canada will likely remain on hold before modest tightening in 2H26
Yogi Berra’s quote “it’s tough to make predictions, especially about the future” comes to mind as
we examine the factors the Canadian fixed income market faces as it rings in 2026. What is easier
to project is that the market faces as many uncertainties in 2026 as it did in 2025.
After cutting its policy rate in September and October, the Bank of Canada (BoC) held rates steady
at 2.25% at its final policy meeting of the year. The Canadian economy has shown greater
resilience than expected in response to the trade war with the employment market delivering
three solid consecutive surprises, albeit the quality of the reports can be questioned. The BoC
stated at its December meeting that its current policy rate is “at about the right level” – or its socalled terminal rate as our Economic/Strategy colleagues phrase it – to achieve its 2% inflation
target while helping the economy through this period of structural adjustment from the ongoing
tariff uncertainty, immigration policy impacts on Canada’s population – which posted a quarterly
decline in Q3 for the first time on record (excluding Covid) – and increased fiscal and infrastructure
spending initiatives.
This clear signaling of the BoC’s reaction function heading into 2026 is interesting as economic
uncertainty remains high and could be exacerbated by the USMCA renegotiations later in 2026,
but the BoC noted that it is prepared to respond should the economic outlook change materially
versus its forecast.
Before taking victory laps, the Canadian economy’s output gap will take some time to close, likely
not until the end of 2026 as soft demand conditions are accompanied by supply constraints such
as tighter immigration policy and weakened supply chains. The CUSMA/USMCA negotiations
form a large part of the uncertainty in 2026 with the U.S. administration facing a mid-term election
year.
As we anticipated, the Canadian yield curve continued to steepen due to the bond market
repricing fiscal sustainability or sovereign risk premia, concerns around inflation expectations with
the stimulative monetary backdrop over the past couple of years, and residual inflation risk from
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