Canada’s annual inflation rate edged down to 3.8% in September on broad-based price reductions, a softer number than the consensus expectation of 4.0%. Core inflation readings also came in weaker than forecast.
This was the last major economic report before the Bank of Canada’s next decision on interest rates next week, and markets reacted swiftly. The Canadian dollar immediately fell by about half a cent to about 73 cents US, although it has recovered some ground since. Canada’s 2-year bond yield, which is sensitive to central bank policy moves, came down sharply as well but was still positive in the wake of the 830 am ET report, fetching 4.926%, up about 2 basis points on the day. It was near 5% before the data hit. Bond yields across the curve in both the U.S. and Canada today are higher following the release of stronger-than-expected U.S. retail sales and industrial production data, but U.S. yields are up more sharply.
Implied probabilities in swaps markets now suggest the odds of another interest rate hike by the Bank of Canada this month have come down considerably. Markets are pricing in about a 15% likelihood that the bank will hike rates at its next policy meeting on Oct. 25, a big decline from 42% prior to the data. For December, markets are pricing in a 32% probability of a further quarter-point hike by the bank, down from 56% odds. Still, markets are only giving modest odds of any cuts on the horizon for next 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 1030 am ET. 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:
Similarly, nearly all economists are now expecting the Bank of Canada to hold rates steady next week. But views differ in what they expect beyond that. Here’s how they are reacting in research reports this morning:
Royce Mendes, managing director and head of macro strategy, Desjardins Securities
Canadian households received a welcome break from price hikes in September. Headline prices declined 0.1% which meant that the year-over-year pace of growth slowed to 3.8% from 4.0%. While lower energy and food prices helped push the overall index lower, air transportation was the single largest contributor to the decline. As a result, excluding food and energy, price growth was weak with just a 0.1% increase in seasonally-adjusted terms.
The Bank of Canada’s core median and trim measures both showed some welcome progress towards taming underlying inflationary pressures. The three-month annualized rate of core median decelerated to 3.5% from 4.4%, while core trim slowed down to 3.8% from 4.2%. Within the trimmed mean, it was core goods and shelter prices which slowed the growth. As a result, it’s not surprising that the three-month annualized rate of core services excluding shelter rose a tick to 4.3%. That said, just 40% of the CPI basket is now above 5%, a 10 percentage point drop from the previous month, suggesting that price stability is now in sight.
The slowdown in most measures of inflation combined with the lower volatility across categories should easily give the Bank of Canada enough confidence to hold rates next week. We continue to believe that the central bank is done for the cycle and that shorter-dated yields are attractive at these levels in Canada. ...
Although today’s CPI data don’t suggest that the battle against excess inflation is over, it does show that central bankers are gaining ground. We continue to believe that the market is pricing in too high a likelihood of further tightening and too long a holding period at terminal. While monetary policymakers will maintain their hawkish tilt next week, we believe that the slowing economy and cooling inflation indicate that the lagged impacts of past rate hikes will be enough to complete the job. That’s particularly true given the recent rise in longer-term bond yields and the ongoing quantitative tightening program operating in the background.
Andrew Grantham, senior economics, CIBC Capital Markets
Canadian consumers can breath a sigh of relief, firstly because inflation appears to be easing again and secondly because that deceleration diminishes the chances of further interest rate hikes from the Bank of Canada. ... While inflation is admittedly still well above target, there were signs within today’s release that the weakening of domestic demand is now starting to impact pricing in some areas and should continue to do so moving forward, without the need for further interest rate hikes. While gasoline prices were slightly down relative to the prior month, the decline wasn’t as large as that seen during the same month of 2022. Because of that, the annual rate of inflation for gasoline accelerated relative to August. However, on the other hand the monthly increase in food prices was weaker than that seen a year ago, seeing the annual inflation rate ease in that area. Mortgage interest costs (MIC) were once again the primary contributor to the monthly and annual changes in prices during September, and excluding those costs the headline inflation rate would have been only 2.9%. CPI inflation excluding food, energy and MIC now sits at 2.1% year-over-year and 1.9% on a three-month annualized basis. Following strong readings in each of the past two months, the Bank of Canada’s preferred core measures of inflation also eased in September, although remained higher than some of our preferred measures of core inflation. CPI trim and median eased to 3.7% and 3.8% year-over-year respectively, down from 3.9% and 4.1% in the prior month, with the three-month annualized rates also decelerating.
The detail of today’s report showed that an easing in domestic demand, combined with improvements in supply, appear to be helping to ease price pressures in some areas where they were most acute a year ago. Air fares were 21% lower in September on a year-over-year basis, helped by an increase in the number of flights. The annual rate of inflation for autos eased to only 1.5%, although prices are still roughly 10% higher than two years ago in a sign that supply constraints have not fully eased in that area. A 4.6% year-over-year decline in furniture prices is probably the clearest indication of how the combination of improved supply chains and easing domestic demand is impacting inflation. With many previously hot areas of inflation now starting to ease, shelter costs are the main source of inflationary pressure. That particularly reflects the previously mentioned mortgage interest costs, but also rental prices where the year-over-year inflation rate accelerated further in September to 7.3%, from 6.5% in August.
With gasoline prices falling so far in October, in contrast to a sharp acceleration seen during the same month a year ago, headline inflation should ease further next month and print close to the upper bound of the Bank of Canada’s 1-3% target range. Even though the Bank’s core measures of inflation remain too high for their liking, some of the details within today’s report, combined with the stall in economic activity seen during Q2 and Q3, should give policymakers comfort that inflation will continue to ease back to 2% without the need for further interest rate hikes.
David Rosenberg, founder of Rosenberg Research
After taking a worrying hiatus in July and August, the disinflationary process looks like it is back underway in Canada. ... Along with the global tightening in long rates, this print gives the BoC a window to allow the lagged impact of interest rate hikes to dampen demand and continue the disinflation process without maintaining an aggressive tightening bias. But, with recessionary pressure building across the economy, the bank should begin to weigh the risks of staying tight for too long.
Jules Boudreau, senior economist at Mackenzie Investments
September’s inflation number is solid evidence that the monster August print was an outlier, not the start of a new trend. Durable goods prices, which accelerated unexpectedly in August, pulled back in September, helped by rising car inventories. Shelter inflation eased back to a high-but-moderate number. We should expect inflation to trend around 3% over the next few months, not the 4%+ trend suggested by August’s print.
This is a reassuring print for the Bank of Canada. Absent an August-like upside surprise for September, we expected the Bank to stand pat at its October 25 decision. With this morning’s downside surprise, a hold is almost certain. While inflation is still above target by every measure imaginable, growth conditions have clearly softened since the beginning of the summer. This makes a striking contrast with what we’re seeing south of the border, where the US Federal Reserve can’t take its foot of the brake with the economy accelerating in recent months. In Canada, the peak in rates is probably in, but we’re not expecting cuts anytime soon: growth will be too soft to support hikes, but inflation too high to justify cuts.
Benjamin Reitzes, managing director, Canadian rates and macro strategist, BMO Capital Markets
Following yesterday’s extremely weak BOS survey, this report should solidify the BoC holding rates steady at next week’s policy meeting. ... Note that next month has a very favourable base effect for headline inflation (not quite as much for core), as CPI surged 0.7% in October 2022. Gasoline prices are down about 7% so far this month, so assuming there’s isn’t a sharp reversal in the next two weeks, we could get a big deceleration in Oct CPI (into the low-3% range).
The softness was pretty broad with a number of categories coming in below our expectations. ...
Key Takeaway: With the Business Outlook Survey pointing to ongoing struggles for the economy (which saw GDP flat-line in the six months to July), and inflation coming in below expected, look for expectations to solidify around the BoC holding policy steady next week. The level of inflation remains much too high for comfort, but the trend is the BoC’s friend here. Given that inflation is the most lagging of indicators, and the economy is clearly weakening, we’re likely to see ongoing disinflationary pressure...there’s no need for further rate hikes in Canada.
Matthieu Arseneau and Alexandra Ducharme, economists with National Bank of Canada
After two consecutive months in which inflation exceeded economists’ consensus expectations, the opposite occurred in September. The widespread nature of August’s significant rise led many to fear the worst. September’s data confirmed our view that this upsurge was temporary, as 7 of the 8 components moderated from last month’s pace. The only exception was food, which rose from 0.20% m/m to 0.27%, which is still much lower than what we’ve seen recently. The widespread moderation in inflation can also be seen in the core inflation measures of the Bank of Canada. On a monthly basis, CPI-trim (+0.20%) and CPI-median (+0.14%) registered their smallest increases in 13 and 33 months, respectively. We think the September data will take a lot of pressure off the Bank of Canada to do more. The central bank had decided to keep rates unchanged at the beginning of September, but had declared itself ready to raise them again if necessary, in the absence of progress on underlying inflation measures. Since then when we look at the three-month change in core inflation measures, we can’t say that things have improved much as it remains stuck in the 3.5% and 4.0% uncomfortable range. But the bank is now facing a dilemma. It was easy to raise rates when the economy still had momentum and was showing signs of overheating. But this is no longer the case. Inflation has surprised them on the rise, but economic growth in the second and third quarters is well below its July forecasts. What’s more, there are no signs of an upturn in the months ahead, with consumer and SME [small and midsize enterprises] confidence now at levels seen only during a recession. It would be perilous for the Bank of Canada to remain focused on sticky inflation with real policy rate the more restrictive since 2008, given the lag in transmitting monetary policy to the economy, and even longer for inflation. According to yesterday’s Business Outlook survey, capacity utilization is now back to normal and weak investment and hiring intentions suggest an even cooler economy in the months ahead. Against this backdrop, combined with the tightening of financial conditions triggered by the global rise in long-term interest rates, we continue to anticipate economic lethargy over the next twelve months without any further BoC tightening.
Derek Holt, vice-president of Capital Markets Economics at Scotiabank
Canadian core measures of inflation noticeably weakened in the latest readings including revisions that lowered prior estimates. ... The Bank of Canada has cover to skip next Wednesday when its Monetary Policy Report tome drops with a dull thud. I expect a hold at a 5% overnight rate with continued guidance that they “are prepared to increase the policy rate further if needed.”
To do anything less than that would violate what I think are ongoing upside risks to trend inflation into 2024. To strike out such a reference would also perversely ease financial conditions relative to what are still priced expectations for a further hiking bias. To pull out the pom poms could make the BoC look rather foolish if the first hint at a soft patch for underlying inflation reverses higher again in subsequent readings. To have faith that this is the beginning of a trend their models have hoped to see for so long would place grossly excessive faith in those models that have not worked well to date. So for now, take the good news, but continue to tread very carefully.
Marc Ercolao, economist with TD Bank
Alongside other measures that have shown momentum in cooling in Canada’s economy, we see enough evidence for the BoC to stand on the sidelines next week, holding the policy rate at 5.00%.
Michael Greenberg, senior vice president and portfolio manager, Franklin Templeton Investment Solutions
This is clearly a better report and recent data from the Canadian business surveys show sentiment falling to its weakest level since 2020 all pointing to a slowing economy. But with the employment markets still strong and inflation still ‘not there yet’ it does keep some pressure on the Bank of Canada. Indeed, companies price setting behaviour has been highlighted as a concern and recent data suggests this could continue to be an issue for the inflation outlook.
However, our view is that the Bank of Canada can be patient – allowing the rate hikes already in the system to ‘do their thing’ – and remain in pause mode for the rest of this year. They clearly need to deal with the still too high inflation but also have no desire to tank the economy, as neither outcome is helpful for Canadian households. This inflation reports points in the direction of patient monetary policy on their part.
Jay Zhao-Murray, forex analyst at Monex Canada, a foreign exchange company
All in all, today’s report is perhaps the best news that the Bank of Canada has received in months, clarifying what was a somewhat mixed run of data since the previous meeting. Despite some indications in yesterday’s surveys suggesting that inflation could prove sticky—firms’ and consumers’ inflation expectations are tracking between 3-4% over the next two years, and wage expectations are high as well—the Bank of Canada will likely take confidence in today’s report and hold rates steady at 5% at next week’s meeting. This is the kind of inflation report that can genuinely make a central banker feel elated. ...
Within the shelter basket, mortgage interest (+2.6%) and rents (+0.8%) drove the increase, with the cost of repairs, taxes, and utilities all holding flat or declining outright. Part of this is the Bank of Canada’s fault—after all, higher overnight rates get passed onto banks, which get passed onto mortgage-holders, and rents see upward pressure from the substitution effect as fewer people opt to buy homes. Governments also can take a share of the blame, having implemented policies that restrain supply and boost the demand for housing. ...
The CPI data also mesh with the latest survey evidence in the sense that consumers display less willingness to spend on goods as opposed to services. Considering that the majority of firms and consumers say that they have not yet seen the full impact of monetary policy on their finances, we anticipate the downward trend in core prices to persist, particularly for goods.
David-Alexandre Brassard, chief economist with the Chartered Professional Accountants of Canada
Inflation came in lower than expected and September marks the first decrease of overall prices levels in 2023. The decrease is broad-based: inflation for services is coming down after strong summer levels, food prices are declining for the second month and inflation on consumer goods has not picked up any further after the August surge. The recent business and consumer outlooks of the Bank of Canada hich note that businesses are planning to raise prices and consumer expectations are both disconnected with today’s statistics. Current inflation does not call for additional interest rate hikes, but the BoC could act to reduce expectations.
Claire Fan, economist, RBC Economics
The slower increase in Canadian consumer prices in September was a step in the right direction. It was also long overdue, given persistent signs of cooling in labour market conditions as well as in consumer spending data. Yesterday’s release of the Bank of Canada quarterly business and consumer surveys further highlighted softening sentiment among both businesses and consumers in Q3, with both groups acknowledging that further slowing in spending and growth can be expected in quarters ahead. Indeed, the lagged impact of interest rate hikes to-date will continue to exert downward pressure on consumer spending as debt payments rise as a share of household incomes, making it more challenging for businesses to raise prices as fast and as frequent. With more easing in inflation readings expected in the months ahead, we expect the Bank of Canada to stay on pause through the rest of the year.
Tiffany Wilding, managing director and economist at investment firm PIMCO
Overall, this release gives the Bank of Canada time to pause and assess the continued pass-through of their previous monetary policy tightening. However, we continue to see risks to the normalization of inflation despite the weak activity backdrop. The continued strength in wages and corresponding stickiness in services ex-shelter inflation, coupled with the lack of progress on short-term inflation expectations in yesterday’s BOC household survey is likely to weigh on policymakers minds.
We expect to hear the Bank of Canada say next week that although they are happy with the continued easing of excess demand in the economy, they are attune to risks of higher inflation expectations becoming entrenched and remain ready to act further if no progress materializes in the near-term on wages or supercore inflation.