Several measures of core inflation have raised eyebrows among financial analysts as the Bank of Canada considers when to lower interest rates. Rental prices have continued to rise, as grocery prices held steady and prices at restaurants have risen by 5.6 per cent over the past year. A server clears a table on a patio at a restaurant, in Vancouver, on April 2, 2021.DARRYL DYCK/The Canadian Press
Some closely watched measures of consumer price growth unexpectedly rose at an accelerated rate in December, showing that inflation is proving tough to tame and potentially complicating matters for the Bank of Canada as it considers when to lower interest rates.
The Consumer Price Index (CPI) rose at an annual pace of 3.4 per cent last month, up from 3.1 per cent in November, Statistics Canada said Tuesday in a report. This result was heavily influenced by what economists refer to as base effects: a tumble in gasoline prices a year ago created an unflattering base for year-over-year comparisons – hence the increase in the annual inflation rate.
Although this uptick was in line with expectations on Bay Street, several measures of core inflation – which strip out volatile movements in the CPI – raised eyebrows among financial analysts. The Bank of Canada’s preferred measures rose at an average annual rate of 3.65 per cent, from 3.55 per cent in November. Analysts were expecting a reading of 3.35 per cent.
In particular, housing prices continue to be a source of financial strain. They rose 6 per cent in December from a year earlier. Rents are generating lots of inflationary pressure, as people – including a surge of international students and other temporary residents – vie for units in short supply.
The Bank of Canada has repeatedly stressed that bringing inflation back to its 2-per-cent target could be a bumpy ride, and that it doesn’t expect to hit that mark until 2025. If core inflation doesn’t subside soon, that could make it difficult for the bank to ease off its main mechanism for restoring price stability: holding interest rates at elevated levels to slow demand in the economy.
After Tuesday’s report, traders pared back their bets on when the central bank will start to lower its benchmark interest rate, but they are still leaning toward April. The Bank of Canada is unlikely to change its key rate from 5 per cent at its next policy decision on Jan. 24.
While bank economists were somewhat alarmed by the upturn in core inflation, they left their forecasts unchanged. Most expect rate cuts to start in April or June.
“If you are looking for data to signal a rate cut is imminent, this isn’t it,” Leslie Preston, senior economist at Toronto-Dominion Bank, said in a client note. “December’s inflation report underscores that the last mile of getting inflation all the way back to 2 per cent is the hardest.”
“Despite December’s report, we expect inflation, and the economy, will have cooled sufficiently by the spring for the Bank of Canada to make its first interest rate cut in April,” she added.
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Tuesday’s inflation report showed some extreme price swings. Canadians paid 31 per cent more in airfare in December than they did in November, because of strong seasonal demand. On the other hand, prices for travel tours tumbled by around 18 per cent on a monthly basis.
At the same time, prices for home entertainment equipment fell 7.2 per cent in a single month.
“While there is clearly seasonality here, the outsized declines hint strongly at softening discretionary spending,” Bank of Montreal chief economist Doug Porter wrote to clients.
In other categories, consumers are clearly feeling the pinch. Rents jumped 7.7 per cent in December from a year earlier, up from a 7.4-per-cent increase in November. “Among other factors, a higher interest rate environment, which can create barriers to homeownership, put upward pressure on the index,” Statscan said in its release.
Economists have noted that Canada’s immigration-driven population surge is creating additional demand for rental housing units, which were already in short supply. “Canada’s housing supply has not kept up with the growth in our population, and higher rates of immigration are widening the gap,” Bank of Canada Governor Tiff Macklem said in a speech last month.
The year-over-year change for grocery prices held steady at 4.7 per cent. At restaurants, prices have risen by 5.6 per cent over the past year.
The short-term trend for the CPI with food and energy costs excluded – a measure of core inflation – is also troubling. The three-month annualized change for that indicator is 3.8 per cent, much higher than central bankers are comfortable with.
In its latest forecast, which was published in October, the Bank of Canada said inflation would linger at roughly 3.5 per cent until the middle of the year, before easing to around 2.5 per cent in the second half of 2024. (The central bank will update its forecasts next week.) Last month, Mr. Macklem said inflation could get close to 2 per cent by late this year, but he also emphasized that disinflation won’t follow a linear path.
“Over the coming months, you should expect to see some push and pull on inflation as the cooling economy reduces price pressures while other forces continue to exert upward pressure,” he said. “That’s why further declines in inflation will likely be gradual. When it’s clear that inflation is on a sustained downward track, we can begin discussing lowering our policy interest rate.”
The Bank of Canada has raised its key interest rate aggressively over the past two years – to 5 per cent from emergency lows of 0.25 per cent – to tackle the biggest price surge in four decades. The impact of these rate hikes is readily apparent in the economy, which has ground to a halt as consumers pull back on discretionary spending. At 5.8 per cent, the rate of unemployment has risen nearly a full percentage point from a record low.
Derek Holt, head of capital markets economics at Bank of Nova Scotia, offered a more skeptical take on Tuesday’s report than many of his peers on Bay Street.
In a client note, he said that “wage growth has been outpacing inflation for an extended period of time. Add in tumbling productivity. The combination of all of that makes it extraordinarily difficult to imagine the BoC cutting any time soon.”