Slower inflation suggests Bank of Canada will hold interest rates

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The Bank of Canada will take its March break from raising interest rates after all.

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Statistics Canada’s consumer price index rose 5.9 per cent in January from a year earlier, a significant decline from 6.3 per cent in December that supports the central bank’s bet that the worst inflation outbreak since the 1980s might be over.

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The drop is significant because Bay Street was starting to wonder whether Bank of Canada governor Tiff Macklem was hasty in January when he said he was prepared to stop raising interest rates and assess whether he had done enough to crush price pressures.

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A couple of weeks later, new data showed employment surged in January, suggesting the economy still had plenty of momentum — even though the central bank had never been more aggressive in trying to cool it down. And last week, evidence emerged that inflation in the United States was hotter than anticipated at the start of the year, raising questions about whether the story would be similar in Canada.

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However, the latest numbers from Statistics Canada suggest inflation continues to drift lower, much as the Bank of Canada said it would in January, when it raised the benchmark rate a quarter point while also promising to hold it there, provided incoming data showed inflation was moving back to its target of two per cent.

Excluding food and energy prices, the consumer price index rose 4.9 per cent from January 2022, compared with a year-over-year increase of 5.4 per cent in December. That’s significant because the headline inflation number is often influenced by volatile prices for commodities such as oil, grain and vegetables. “Core” prices, which are indicative of the underlying trend, appear to be falling, albeit not fast enough to dissuade market participants that additional interest rate increases could be necessary to truly crush inflation. Two separate measures of core inflation that the Bank of Canada watches to gage the trend also were around five per cent, a long way from the central bank’s target.

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“The Bank of Canada has clearly telegraphed an imminent pause in its tightening cycle and today’s data should support expectations for a lack of action at the next meeting” on March 8, Karl Schamotta, chief market strategist at Cambridge Mercantile Corp., said in a note to his clients. “But core price pressures remain well above the institution’s target range, making another quarter-point interest rate hike reasonably possible in the coming months.”

The headline number was flattered to a certain extent by what Statistics Canada called a “base-year effect.” In January 2022, the consumer price index jumped 0.9 per cent from the previous month, a relatively big increase caused by higher energy prices amid signs that Russia intended to invade Ukraine. Supply chains were also a mess, and housing prices were rising.

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This year, conditions are entirely different. Energy and housing costs are lower, and supply chains are easing. The consumer price index increased only 0.5 per cent on the month, so the comparison with the year-ago period is necessarily lower than it was at this time in 2022.

A monthly increase of 0.5 per cent represents a big jump from December, when the consumer price index declined 0.6 per cent from the previous month. Statistics Canada said a 4.7 per cent jump in gasoline prices was mostly to blame, so the sudden upward pressure should dissipate. That’s because the winter storm Elliot caused a momentary supply shock by forcing the closure of refineries in the southwestern United States.

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