Shares of Toronto-Dominion Bank (TSX:TD), Bank of Montreal (TSX:BMO) and National Bank of Canada (TSX:NA) fell on Friday, October 30, as investors worried that higher interest rates are here to stay.

Two days after the Bank of Canada raised its Key Rate for the first time in about three years, fresh data showed Canada's economy stalled in August. Rising oil prices added to fears that inflation, and rates, could climb further.

What happened

All three banks each slipped by a little more than one-hundredth of their value during Friday's session.

None of the three issued a news release tied to the move on Friday, and no analyst rating changes were reported. The declines reflected pressure on the whole sector rather than company-specific news.

Financial stocks were one of the larger drags on the S&P/TSX Composite Index, which fell about 629 points to close at 35,620.03. It was the index's steepest one-day drop since June.

Why it matters

On Wednesday, October 28, the Bank of Canada raised its overnight rate by a quarter of a point, its first hike since July 2023. Governor Tiff Macklem pointed to rising inflation, much of it linked to oil prices from the war involving Iran.

Markets now expect the Central Bank to raise rates again by January.

That is a mixed picture for banks. Higher rates can widen the gap between what banks earn on loans and what they pay on deposits. But they also squeeze borrowers. Variable-rate Mortgage payments rise right away, and heavily indebted households and businesses may struggle to keep up. That raises the risk of Loan losses.

Friday's economic data made that worry sharper. Statistics Canada said the economy stalled in August, the second straight month without growth. A slowing economy combined with rising rates is a tough mix for lenders.

The bigger picture

Oil is at the centre of the story. Crude rose above US$100 a barrel on Friday after a tanker attack in the Strait of Hormuz. Energy-driven Inflation concerns have weighed on major banks since the start of the U.S.-Iran war.

The rest of the market had problems of its own. Gold fell to a one-year low and dragged down miners, while tech stocks slid after weak results from Intel and Amazon. Decliners outnumbered advancers 661 to 339 on the TSX.

Energy was one of only two sectors to finish higher, helped by the oil rally.

For bank investors, the key question is whether the Bank of Canada can cool inflation without tipping the economy into a downturn. The central bank has said it expects inflation to keep climbing through the end of the year, from an already elevated reading in September.

What to watch next

The Big Six banks close their fiscal year at the end of October, so fourth-quarter results are still weeks away. Investors will look closely at loan-loss provisions, mortgage renewals and how much Credit quality has weakened.

Management commentary on those calls will show how lenders are preparing for a slower economy and higher borrowing costs at the same time.

Inflation data will also be key. A hotter reading would boost the odds of another hike by January.

Oil prices could swing the outlook too. Any easing of tension around Hormuz would cool inflation fears and could ease pressure on bank shares.

For now, the market is treating rate worries as bad news for Canada's big lenders.