Today’s inflation report has solidified bets in money markets that more monetary easing is coming soon from the Bank of Canada. Economists have a very similar view.
Canada’s annual inflation rate cooled to a 40-month low of 2.5% in July, matching forecasts, and core inflation measures eased as well. The inflation rate is now the closest to the Canadian central bank’s 2% target since 2.2% inflation in March 2021, when prices were beginning to rise after about a year into the coronavirus pandemic.
The Bank of Canada has already cut its policy rate at two consecutive policy-setting meetings, bringing its overnight rate to 4.50%.
Market reaction to the CPI data was pretty subtle, as the numbers largely matched Street expectations. The Canadian dollar did dip - by about one-tenth of a cent to 73.38 cents US - given the fresh numbers would appear to almost guarantee a third Bank of Canada rate cut come September. The Canada two-year bond yield, which is particularly sensitive to central bank policy, fell by a few basis points too, to 3.319%.
Money markets are fully priced for a Bank of Canada rate cut on September 4, and in the wake of the data, traders see some - but modest - risk of a large 50 basis point cut at that meeting. Implied interest rate probabilities in swaps markets suggest a 96% chance of a 25 basis point cut, and about a 4% chance of a 50 basis point cut, according to LSEG data. Prior to today’s data, swaps pricing suggested less than a 1% chance of the larger 50 basis point cut.
Money markets are also nearly fully pricing in additional rate cuts at the October and December Bank of Canada meetings, which would bring the overnight rate to 3.75% by the end of this year. Looking further out, markets are priced for an overnight rate of 2.63% by October 2025 - almost a full two percentage points below current levels. Of course, a lot can happen between now and then - but markets for the moment are anticipating steady declines in the overnight rate well into next year.
Here’s how implied probabilities of future interest rate moves stand in swaps markets, according to data from LSEG as of 850 am ET. 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 a look at the probabilities as of late yesterday, before the data.
Here’s how economists are reacting:
James Orlando, director and senior economist, TD Economics
Canadian inflation continues to ease, with headline and core rates stabilizing around the mid-2% level. When stripping out the impact of shelter inflation, price growth is a meager 1.2% y/y. Looking forward, the downward impact of base effects will continue to support lower inflation next month, pushing the headline figure even further towards the BoC’s target.
The BoC makes its next rate announcement in two weeks and there is nothing stopping the bank from cutting rates by another 25 basis points. With inflation risks fading, the central bank’s focus has pivoted to weakness in the rest of the economy. Indeed, consumer spending looks to have taken a breather alongside a steady deterioration in the jobs market. Given that the policy rate remains at restrictive levels, even after two rate cuts in June/July, there is plenty of room for the BoC to keep cutting over the rest of this year.
David Rosenberg, founder of Rosenberg Research
The bee in the bonnet of inflation-phobes all along has been the shelter component, but that softened to show just a +0.2% MoM increase last month, the faintest pulse in nearly a year and half. So, the lags from the prior BoC rate hikes, which have softened the residential real estate market, are finally showing through in the various housing components. And the unwillingness of Canadians to deploy savings toward current consumption was revealed by the -0.2% MoM deflation in recreation service prices, after a -0.7% slide in June (now running completely flat on a YoY basis). Strip out the shelter component, which is still running at +5.7% YoY (though clearly off the boil), and the other 70% of the pricing pie is now seeing inflation at a mere +1.2% year-over-year pace from +2.6% a year ago.
All very much a friendly report for bonds — less so for the Canadian dollar. The Bank of Canada would be well advised to bring its policy rate into alignment with underlying inflation, which would mean rolling back most — if not all — of that unnecessary John Crow-like tightening cycle in 2022 and 2023 that took the policy rate up from 1.75% pre-pandemic to the 5% peak. The labor market and inflation have done more than just “normalize,” and yet, even with two rate cuts under its belt, the BoC has a very long way to go to “normalize” monetary policy.
Claire Fan, economist with Royal Bank of Canada
Today’s CPI print should be enough to quell concerns about sticky inflation pressures in Canada after two marginal upside surprises in May and June. Readings were unequivocally weak – with slowing evident among all core CPI measures. The scope of price pressures also continued to normalize – the diffusion index says the breadth of inflation in Canada is looking similar to pre-pandemic norm in 2019. That’s good news for the Bank of Canada, who is actively turning their focus onto a weakening economic backdrop and the disinflationary pressures that could stem from that moving forward. The hurdle for more BoC cuts this year is low and we continue to look for another 25 basis point cut at their next meeting in September.
Andrew Grantham, senior economist, CIBC
Canadian inflation continued to ease in July, keeping the door to further interest rate cuts wide open. Headline inflation eased to 2.5% year-over-year, on the back of a 0.4% NSA (0.3% SA) increase in prices on the month, with both of those figures matching consensus expectations. Gasoline prices were the largest contributor to the monthly increase in prices, and mortgage interest costs are still adding notably to inflation even as interest rates have started to come down. While air transport and travel tours saw a seasonal jump in price, the increase this year was weaker than in 2023 and as a result prices were lower on a year-over-year basis. Core measures of inflation were fairly subdued in July, with ex-food/energy prices up only 0.2% on a seasonally adjusted basis (even with mortgage interest costs still advancing) and CPI-trim and CPI-median both advancing by a slight 0.1% m/m. With inflationary pressures fading away but concerns about the weakening labour market growing, we continue to forecast three further 25bp cuts by the Bank of Canada at the remaining meetings this year.
Olivia Cross, North America economist, Capital Economics
The softer monthly gains in the Bank of Canada’s preferred core price measures in July suggest that the previous two months reflected normal volatility rather than a stalling of the downward trend in core inflation. With core inflation on track to surprise to the downside of the Bank’s latest forecasts, there is not much now that could derail another interest rate cut at the early September meeting. If anything, there is a growing possibility of a larger 50 bp cut later this year.
The 0.3% m/m seasonally adjusted rise in the headline CPI was smaller than we expected and brought the headline rate down to 2.5%. That downside surprise was helped by a much softer 0.3% m/m rise in food prices, after some unusually strong gains in May and June. Shelter price gains also moderated, rising by just 0.2% m/m in July. That was largely due to another soft rise in rent prices, which suggests that the slowdown in rent inflation is happening earlier than we initially expected.
Ultimately, the softer 0.1% m/m average gain in CPI-trim and CPI-median shows that the disinflationary pressures in July were encouragingly broad based. For now, the three-month annualised rate is still 2.7%, down from 2.9%, but if the recent momentum continues then core inflation would undershoot the Bank’s forecast for the average of CPI-trim and CPI-median to be 2.5% in the third quarter. While that alone is probably not enough to prompt the Bank to cut interest rates by a larger 50bp, it does leave the door open for the Bank to take a larger step later this year if there is additional weakness in the labour market or activity data.
Benjamin Reitzes, managing director, Canadian rates & macro strategist, BMO Capital Markets
The core inflation figures were very encouraging, with the Trim and Median CPIs both up 0.1% m/m. That cut the yearly rates one-to-two ticks to 2.7% and 2.4%, respectively, the lowest since April 2021. Short-term inflation metrics also headed in the right direction, with the three-month rates both easing to 2.7% and six-month rates holding just above 2%.
The July CPI report should further cement a 25 bp rate cut from the Bank of Canada in September. There’s no urgency for policymakers to act more aggressively at this point, but rate cuts will keep coming as inflation continues to move toward 2% and the economy sports a sizeable output gap.
Charles St-Arnaud, chief economist, Alberta Central
Overall, the Bank of Canada will welcome today’s report as it confirms that inflation continues to ease. Moreover, the breadth of inflationary pressures and the momentum of core inflation suggest further progress. Nothing in the CPI report would concern the BoC and could prevent a 0.25bp cut at the next meeting in September. While some have argued that the BoC should cut by 0.50bp because of the recent softening of the economy, we believe such a decision would signal that the BoC is behind the curve and in panic mode. While the labour market has been soft lately, it does not justify an aggressive cut. Nevertheless, with inflation clearly within the BoC’s target and expected to continue to moderate slightly, the focus of the BoC is turning to the lacklustre economy. With this in mind, we think the BoC will cut at every meeting this year (Sept, Oct, and Dec) to end the year at 3.75%.
Tu Nguyen, economist with assurance, tax & consultancy firm RSM Canada
Canada’s disinflation solidifies the case for a September rate cut as the Consumer Price Index fell to 2.5% with broad-based easing of price increases across categories, from food to recreation and, most notably, shelter.
Shelter has been the most stubborn piece of the inflation puzzle, which the Bank of Canada has finally begun to crack. Perhaps paradoxically, recent rate cuts are helping to dampen shelter inflation.
Mortgage interest costs grew at a slower rate in July as the policy rate dropped from 5% to 4.5%. Households renewing their mortgages in July experienced a smaller sticker shock compared to those who renewed just months earlier. Further easing of the policy rate will continue to put a lid on the rise of mortgage interest costs.
The other reason is the slowdown in rent growth, brought about by a combination of stronger supply and weaker demand. Condo units started during the pandemic have now hit the market, adding to the rental supply. At the same time, a slowdown in immigration numbers due to recent restrictions of international students and temporary workers curb demand.
Inflation numbers have consistently come in below expectations this year and is firmly on track to reach 2% next year. We expect the Bank of Canada to announce two more 25-basis point rate cuts this year and a series of 25-basis point cuts in 2025 until the terminal rate is reached.
Nick Rees, senior forex market analyst, Monex Canada (foreign exchange firm)
Looking through the July CPI figures, there is little to favour anything other than a succession of 25bp cuts from the BoC as we see it. Not only did the headline figure ease, but price growth also fell 0.15pp to 2.7% YoY after excluding volatile food and energy components. Perhaps more relevant for the Governing Council, the BoC’s preferred measures of underlying inflation recorded another drop last month. Core trim-CPI growth fell to 2.7% YoY, 0.1pp below a downwardly revised June reading of 2.8%. Similarly, core-median CPI slipped to 2.4% YoY, 0.2pp down from 2.6% in June. Moreover, while less of a focus for policymakers, our own favoured measures of underlying inflation also slowed last month. Core CPI ex-shelter fell from 0.74% YoY to 0.65%, while the less restrictive CPI excluding rent and mortgage costs slowed from 0.91% YoY to 0.85%. In short, whichever way the data is sliced, July saw further disinflation progress.
Even the one spot of notable inflation resilience in the consumption basket is now showing signs of disinflation progress. Granted, shelter inflation remained elevated at 5.7% YoY in July, but this was down from the 6.2% reading seen in June. This is a notable move in the right direction for a component where disinflation progress had appeared to stall in the first half of the year, a point confirmed by shorter-run momentum measures – shelter inflation also ticked down from 5.0% to 3.8% on a 3mma. annualised basis.
That said, we think it remains a high bar for the Governing Council to deliver 50bps of easing at any point in 2024. The BoC’s shift in focus to a broader examination of economic conditions, and in particular economic slack, suggests to us that this would require signs of a hard stop in growth, or a rapid unwind in the labour market. Despite our longstanding bearishness on the Canadian economy, neither of these looks likely to us at present. With this in mind, we continue to see 25bp rate cuts as the base case for every BoC through to the end of the year a view also shared by markets, which now have a rate cut priced for each of the BoC’s three remaining meetings. Where we are at odds with market pricing is regarding USDCAD, which continues to flirt with 1.36 having barely budged following today’s data print. These levels look cheap in our eyes, though supported for now by aggressive Fed easing expectations and a recent rally in equities, a dynamic that looks unsustainable to us. We continue to expect the pair to retrace higher, perhaps as early as this week, with FOMC meeting minutes and commentary from Jackson Hole both notable risk events.
Derek Holt, vice-president, Scotiabank Economics
Our forecast is for two more cuts this year including September, ending the year at 4%. We tentatively assume a skip in December partly based on uncertainty in the aftermath of the US election, domestic data uncertainty, and the potential contents of a Fall fiscal update into an election year. ...
Figures for August and September may be interesting ...
Near-term price pressures partly depend on how long the likely rail strike lasts and how pervasive its effects may be. What has me worried about the duration is that both sides are saying they remain far apart and that the labour regs have changed given the left wing Federal government’s pro-union policies that are against intervention. This raises the risk of supply shocks at a key time for retailers that are ordering their goods for the holiday season. A short strike is no big deal. A prolonged one could be quite disruptive to stocking and prices. Ditto for some key commodities like potash, wheat, etc. Oil by rail is less susceptible with those flows roughly tied with the lows of the past decade in part due to TransMountain.
Bryan Yu, chief economist with Central 1 credit union
The latest inflation aligns with our forecast of normalizing inflation, although a touch slower than anticipated. Nevertheless, constructive trends in July points to a natural hat trick with third straight Bank of Canada cut as employment data will not be out until September 9th. That said, it is unlikely we will see any super-sized moves. We expect the policy rate to end the year at 3.75 per cent.