Canada’s annual inflation rate rose to 3.4% in December from 3.1% in November, while on a monthly basis, consumer prices fell 0.3% from November.
While those numbers matched Street expectations, core readings suggested stubborn inflation would still be a problem for the Bank of Canada. One of the bank’s core measures of underlying inflation, CPI-trim, edged slightly higher to 3.7%, while CPI-median stayed at 3.6%.
Markets were taken a little off guard with the higher-than-expected core readings of inflation, with the Canadian dollar immediately rising to 74.30 cents US, up about a tenth of a cent. It didn’t take long, however, for the loonie to relinquish those gains, and by 10 am ET, was trading lower on the session and retesting the 74 cent level.
Global bond yields were already ticking higher this morning prior to the inflation report. But the two-year government of Canada bond yield, which is particularly sensitive to Bank of Canada policy moves, bumped up an additional couple basis points following the data. At 842 am ET, the two-year bond was fetching 3.873%, up about 9 basis points for the session and roughly double the rise in the yield in the equivalent U.S. note.
That upward move in bond yields became more pronounced later during the North American trading day as traders absorbed comments from central bankers in Europe and the U.S. that suggested no rush towards easing monetary policy. By 2pm ET, both the Canada two-year and five-year yields were up about 15 basis points.
Implied interest-rate probabilities in swaps markets saw modest moves as well, but nothing that dramatically changes what traders see ahead for moves this year in the Bank of Canada overnight rate. Markets are pricing in about a 31 per cent chance of a cut in the BoC overnight rate at its March meeting, rising to 74% odds by April. Prior to today’s inflation release, those probabilities stood at 40% and 87%, respectively.
Regardless, money markets remain convinced we’ll see the bank start cutting rates in the first half of this year, with 99% odds of at least a quarter point cut by June. Nearly 125 basis points of cuts are currently priced into markets by the end of this year.
The following table details how money markets are pricing in further moves in the Bank of Canada overnight rate, according to Refinitiv Eikon data as of 845 am. The current Bank of Canada overnight rate is 5%. While the bank moves in quarter point increments, credit market implied rates fluctuate more fluidly and are constantly changing. Columns to the right are percentage probabilities of future rate moves.
And here’s how the swaps pricing looked just prior to the inflation report:
Economists were also a little surprised by the rise in core readings. They highlight that those looking for rate relief will need to be patient.
Here’s how they are reacting this morning:
Royce Mendes, managing director and head of macro strategy at Desjardins Securities
The reacceleration in Canadian inflation is going to raise some eyebrows. While the increase in the annual rate of price growth to 3.4% in December from 3.1% in November was simply the result of base effects and in line with the consensus forecast, core measures of inflation were expected to have cooled further during the month. Alas, that was not the case. The Bank of Canada’s two core indicators both accelerated, with the average three-month annualized rate of the two rising to 3.6% from an upwardly revised 2.9% in the prior month.
As a result, the underlying pace of price pressures looks hotter than we anticipated. The only reason that headline inflation printed in line with the consensus forecast seems to be as a result of a few large price declines in categories such as cellular services. The reacceleration in the core trimmed mean measure actually looks quite broad based, with the three-month annualized rates of core-goods, core-services excluding shelter and core-shelter prices all moving higher in December.
The stickiness in these core measures of inflation comes as a disappointment to Canadians hoping to see enough progress today to open the door to rate cuts. Canadian rates are rising following the release, particularly at the shorter-end of the curve, as traders reassess some of their aggressive rate cut bets. That said, given the moderation seen in expectations for both growth and inflation according to yesterday’s consumer and business surveys from the Bank of Canada, we are sticking with our call that the central bank will begin lowering rates in April to keep the economy from falling into a deeper recession.
Stephen Brown, deputy chief North American economist, Capital Economics
The pick-up in underlying inflation pressures raises the risk that the Bank of Canada will need to keep interest rates higher for longer than markets are now pricing in, with the economy suffering further as a result. ...
At first glance, the more modest 0.2% m/m seasonally adjusted rise in the CPI excluding food and energy, following the 0.4% increase in November, looks encouraging. But that seems to have been entirely due to a normalisation of travel tours prices after they surged in November, which pulled recreation, education & reading prices down by 1.3% m/m. Household operations, furnishings & equipment prices also fell again, by 0.2%, and there was a smaller 0.4% rise in shelter prices, likely due to a smaller increase in mortgage costs. There were larger increases elsewhere, however, with a rise in vehicle prices and a surge in airfares pushing the transportation index up by 1.6%, while clothing prices once again rose by 0.5%.
The most disappointing element of the CPI data is that the CPI-trim and CPI-median measures both rose by 0.4% m/m, which caused the average three-month annualised rate to jump back up to 3.6%, from 2.9%, while the average annual rate also edged higher. As the Bank pays more attention to those core measures than the CPI excluding food and energy, those larger increases mean the Bank is likely to remain a hawkish tone at its meeting next week and reduce the chance of it cutting interest rates any time soon.
Leslie Preston, managing director and senior economist, TD Economics
If you are looking for data to signal a rate cut is imminent, this isn’t it. December’s inflation report underscores that the last mile of getting inflation all the way back to 2% is the hardest. It took about a year for inflation to drop from its peak of 8% to around 3%, but over the past six months further headway has been halting. This leaves the Bank of Canada cautious as it considers when it will be appropriate to cut interest rates.
Despite December’s report, we expect inflation, and the economy, will have cooled sufficiently by the spring for the Bank of Canada (BoC) to make its first interest rate cut in April. That said, inflation is unlikely to be quite at 2%. As Governor Macklem pointed out in December, the BoC doesn’t need to see 2% to begin normalizing monetary policy, but rather be confident it is getting there.
Derek Holt, vice-president and head of capital markets economics at Scotiabank
The latest inflation evidence continues to push back against market pricing and some forecasters’ views that the Bank of Canada will be cutting by the March and April meetings. March has been mostly wiped out and April’s cut pricing was further reduced.
Not going to happen folks. I’ve argued for a long time that one should be paying those contracts; doing so would have paid off handsomely by now. In fact, I think an awful lot has to go right from here in order to get the BoC to be cutting by the consensus call for around mid-year or even this year and to this point I just don’t see the required evidence.
Key is that the BoC’s preferred gauges of underlying inflation accelerated again. Trimmed mean CPI—that lops off the top and bottom 20% of the CPI basket—landed at 4.8% m/m at a seasonally adjusted and annualized rate. Weighted median CPI—that takes the 50th percentile price—was up by 4.7% m/m SAAR. Both readings are far above the BoC’s 2% inflation target and signal no progress toward achieving it any time soon. These are central tendency inflation measures totally unaffected by outlier price changes like mortgage interest.
Claire Fan, economist with Royal Bank of Canada
Shelter inflation continues to account for a disproportionate share of price growth as past interest rate increases continue to pass through to mortgage costs with a lag. Shelter inflation rose to 6% in December on a yearly 7.7% increase in rents and 28.6% surge in mortgage interest costs (the latter now slightly off the peak of 31% in August).
Today’s CPI report was more mixed than the headline reading would suggest. The acceleration in airfares and car price growth in December is unlikely to be repeated and strength in the shelter component, especially in rent prices also persists. Still, over on a three-month annualized basis the scope of inflation pressures continues to narrow/improve – suggesting on balance that price pressures were still unwinding. The quarterly release of the BoC surveys yesterday also provided more indications that price growth should continue to slow, as businesses plan for smaller / less frequent upward price adjustments in the year ahead amid a slower economic backdrop and sluggish consumer demand. We continue to expect the BoC to tread cautiously and watch the data carefully, but for further slowing inflation to allow a pivot to interest rate cuts around mid-year.
Douglas Porter, chief economist, BMO Capital Markets
While the higher headline was little surprise, and precisely mimicked the U.S. inflation experience in December, the slightly more unsettling news is the persistence of core in the mid-3s. That sticky theme was echoed in yesterday’s Business Outlook Survey, and suggests that the last mile (or kilometre) of the inflation fight may prove to be the most challenging—bringing underlying inflation sustainably back below 3%. Given that wage trends are also stuck in the 4%-to-5% range, and now even housing may be showing a pulse, suggests that the Bank of Canada will doggedly maintain a cautious stance at next week’s rate decision and Monetary Policy Report. We are comfortable with our call of a first rate cut at the June meeting, even as the market leans in earlier.
Matthieu Arseneau and Alexandra Ducharme, economists with National Bank Financial
If it were just the country’s inflation situation (CPI and wage data), we’d recommend that the central bank stay on its toes. However, we have repeatedly pointed out that inflation is a lagging indicator of economic conditions and that it would be dangerous to base future monetary policy solely on current price pressures, given the lag in transmission to the economy. The latter is showing several signs of weakening, as evidenced by faltering economic growth and a sharp rise in the unemployment rate. According to the Bank of Canada’s Business Outlook Survey, a significant number of firms are already reporting declining sales (39%), and further deterioration is expected (char), which does not bode well for a pickup in hiring. With labour shortages now a thing of the past, according to the same survey, inflationary fears are less and less on our radar for 2024.
Katherine Judge, director and senior economist, CIBC World Markets
Headline inflation likely won’t fall into the Bank of Canada’s target range for a few months, but the key to our call for the Bank to start cutting interest rates in June will be further progress in core measures, particularly excluding shelter costs, which are being impacted directly by the Bank of Canada’s previous interest rate hikes. Sluggish economic growth and the deterioration in the labour market should leave underlying core measures on a decelerating track ahead. Bond yields climbed following the upside surprise in CPI-trim and median, although the market is still pricing in too high of a chance of rate cuts in the first half of the year in our view.
Jules Boudreau, senior economist at Mackenzie Investments
The economy is slowing, with non-public job creation having ground to halt over the past few months, and its overall macro condition is consistent with 2% inflation. One month of strong inflation doesn’t derail a trend, but it’s certainly enough to rule out any softening of language at the Bank of Canada’s upcoming meeting.”
Charles St-Arnaud, chief economist, Alberta Central
The faster inflation momentum, as measured by the 3-month annualized changes, suggests that the rise in the y-o-y measures is not only due to a base effect. This is also confirmed by the broader inflationary pressures in December and the faster momentum in the BoC’s measures of core inflation. Some base effects in the coming months is likely to push inflation higher, both headline and core measures, to around 3.5% over the next few months. As such, the momentum measures will remain key to assessing inflationary pressures.
The increase in headline inflation, the relatively unchanged core inflation and the rise in core inflation’s momentum will provide reasons for the BoC to remain cautious on inflation. As such, we believe it remains too early for the BoC to officially declare victory on inflation. Looking ahead, the BoC is unlikely to contemplate rate cuts until inflation has been brought sustainably below 3%. This is unlikely to happen until the Spring and could be delayed if inflation proves to be stickier than expected.
Nick Rees, forex market analyst at Monex Europe
A more worrying development for the BoC, however, will be the increase in core inflation readings, with both core-trim and core-median inflation readings printing above expectations. Policymakers will likely point to this uptick as a basis for holding rates high for longer, posing a risk to our forecast for the BoC to ease in early 2024. If they do though, this will come at the cost of growth, which should in turn see inflation cool rapidly given an economy already on the brink of recession. All told, despite the strength of today’s numbers pointing to a BoC that could keep policy tighter than we previously thought, this is hardly a positive environment for the loonie if it comes at the cost of a nasty recession for the Canadian economy.
Looking forward, we still think there is reason to expect inflation to fall faster than today’s number might initially suggest. Specifically, we continue to see the labour market softening, a point highlighted by yesterday’s Business Outlook Survey. Not only this, but the survey pointed to a moderation in output prices over coming months, with easing demand and increased competition meaning fewer firms are now planning unusually large price increases.
Tiffany Wilding, managing director and economist, PIMCO
Overall, today’s report is likely to be unwelcome news to the Bank of Canada (BOC). Rent and mortgage interest costs continue to be major contributors to core inflation, while inflation from other components is continuing to rebound from its October low. Given there is only one CPI release before the March meeting (and two before April), it seems unlikely that there will be a significant enough slowdown in inflation to make the BOC comfortable with cutting interest rates at these meetings, barring a separate catalyst.