Inflation cools to 2.7% in April, increasing odds of a summer interest rate cut

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Canada’s inflation rate is cooling as higher interest rates work to restrain price growth, bolstering the case for the central bank to start cutting rates this summer.

The Consumer Price Index rose 2.7 per cent on an annual basis in April, Statistics Canada reported on Tuesday, down from 2.9 per cent in March and matching analyst expectations.

Not only did the annual inflation rate hit a three-year low, but it’s fallen within the Bank of Canada’s target band of 1 per cent to 3 per cent for four consecutive months. Measures of core inflation, which strip out volatile movements in the CPI, are also slowing.

After a string of tame inflation reports to start 2024, the central bank is nearing the point of lowering interest rates. The question is whether that will happen in June or at a later date. With Tuesday’s CPI report, investors raised their bets for a June cut, although it’s still close to a coin-toss outcome.

A loosening of monetary policy will mark a significant milestone for the Canadian economy, which has struggled with the largest bout of inflation in four decades. The Bank of Canada has aggressively raised interest rates to curb demand in the economy and ultimately bring inflation back to its 2-per-cent target.

In turn, higher borrowing costs have ratcheted up financial pressure on indebted households and governments, forcing many families to tighten their budgets and spend less on discretionary items.

“Canadians look likely to get a small dose of rate relief in the coming weeks,” wrote Royce Mendes, head of macro strategy at Desjardins Securities, in a client note. With several measures of inflation in a downward trend, “Canadian central bankers should have the evidence they need to begin easing monetary policy.”

The April inflation report showed several areas of weakening price pressures.

Grocery prices rose at an annual rate of 1.4 per cent in April, down from 1.9 per cent in March. (They had peaked at roughly 11 per cent during this inflation crisis.) Meat prices rose 1.8 per cent over the past year, while many products – such as fresh fruit, fish and milk – are experiencing price declines.

Clothing and footwear prices fell by 2.6 per cent in April, year over year, while those for household operations, furnishing and equipment dropped by 2.1 per cent.

Consumer prices rose 0.5 per cent in April from March, largely because gasoline rose by nearly 8 per cent in a single month.

Housing costs continue to be a concern for homeowners and tenants. Rents have jumped by 8.2 per cent over the past year. While this was a touch weaker than in March (8.5 per cent), the housing shortage won’t be easily fixed, all but ensuring that Canadians will face an affordability crunch in that area for years to come.

In Alberta, for example, rents have soared by 16.2 per cent since April, 2023. Statscan said this increase has coincided with strong migration into the province.

After the most recent rate decision in April, Bank of Canada Governor Tiff Macklem said he was encouraged by the downward trend for inflation, but that he wanted to see it play out for longer. Amid a multiyear fight to tame inflation – the bank has raised its policy interest rate to 5 per cent from emergency lows of 0.25 per cent – central bankers are wary of cutting rates too early and inflaming prices.

But since Mr. Macklem’s comments, the weakening trend for inflation has persisted over two CPI reports.

The central bank’s preferred measures of core inflation rose at an average annual rate of 2.75 per cent in April, down from 3.05 per cent in March. This was the first reading below 3 per cent since mid-2021.

The CPI, excluding food and energy, rose by 2.7 per cent in April, year-over-year, compared with 2.9 per cent in March. On a three-month annualized basis, this measure of core inflation is running below 2 per cent.

Interest-rate swaps, which capture market expectations of monetary policy, are pricing in a roughly 60-per-cent chance that the Bank of Canada cuts its policy rate by a quarter-percentage-point at the next decision on June 5, according to Bloomberg data. Prior to Tuesday’s CPI report, those odds were 43 per cent.

If the bank doesn’t cut in June, investors fully expect that to happen on July 24.

Still, Mr. Macklem has indicated that interest rates will be lowered more gradually than they were raised, and that consumers shouldn’t expect a return to the rock-bottom rates that were a mainstay of the economy after the 2008 financial crisis, and later, during the COVID-19 pandemic.

As well, the Bank of Canada will be influenced by the actions of the U.S. Federal Reserve, which is widely expected to start cutting later in the year. This divergent path for interest rates would put downward pressure on the Canadian dollar, thereby raising the price of imported goods.

“We believe that the door is open for a BoC rate cut, and we have been leaning to June move for the past six months,” said Doug Porter, the Bank of Montreal’s chief economist, in a client note.

“But it remains a close call, and when the bank does eventually move, it will be gradual with a highly patient Fed acting as a limiter on how far and how fast Canadian rates can fall.”