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Canada’s inflation rate unexpectedly fell last month, and underlying price pressures appear to be fading fast, opening the door for the Bank of Canada to discuss lowering interest rates.

The Consumer Price Index rose 2.8 per cent in February on an annual basis, down from 2.9 per cent in January, Statistics Canada said Tuesday in a report. Analysts were expecting an upturn to 3.1 per cent. This was the second consecutive month that CPI growth has undershot estimates by a wide margin.

The inflation rate has also resided within the Bank of Canada’s target range of 1 per cent to 3 per cent for two consecutive months – the first time that’s happened since early 2021.

The results suggest higher interest rates are not only working to bring inflation under control, but also on a faster timeline than central bankers expected. In January, the Bank of Canada projected that annual inflation would average 3.2 per cent in the first quarter.

The economy has slowed to a crawl as it contends with restrictive interest rates, and many consumers have reduced their spending since the Bank of Canada’s rate-hike campaign began in early 2022. The bank has intentionally sought to curb demand in the economy as part of its efforts to tackle inflation.

How economists and market bets for rate cuts are reacting to today’s surprisingly soft Canadian inflation data

After Tuesday’s report, investors ratcheted up their predictions of a summer rate cut. Interest-rate swaps, which capture market expectations about monetary policy, are pricing in a roughly 80-per-cent chance that the Bank of Canada cuts rates by a quarter of a point at its June meeting, up from about 50 per cent before the report, according to Bloomberg data.

“Monetary policy makers will be able to breathe a sigh of relief after seeing these numbers,” Royce Mendes, head of macro strategy at Desjardins Securities, said in a client note. “We expect central bankers will sound more dovish in April, thereby setting up a rate cutting cycle beginning in June.”

After many months of decline, gasoline prices rose an average of 4 per cent in February from January, a big reason why economists had pencilled in a higher rate of overall inflation.

However, this increase was offset by weakness in other categories. Consumers who subscribed to a cellphone plan in February paid 26.5 per cent less than a year earlier, while prices for internet service fell by 13.2 per cent. Clothing and footwear prices dropped by 4.4 per cent and 5.3 per cent, respectively.

Canadian dollar hits three-month low as CPI surprise lifts rate cut bets

The grocery sector is another area of progress. The price of food purchased from stores rose by 2.4 per cent in February on a 12-month basis, down from 3.4 per cent in January. Grocery inflation had peaked at more than 11 per cent in 2022 and 2023.

Even so, grocery prices have risen by nearly 22 per cent over the past three years, compared with an overall CPI increase of 14 per cent. “While price growth for groceries has been slowing, prices continue to increase and remain elevated,” Statscan said in its report.

An encouraging sign for the Bank of Canada is that core measures of inflation, which strip out volatile price movements, are subsiding quickly. On a three-month annualized basis, the central bank’s preferred measures of core inflation have slowed to an average of 2.2 per cent from 3.1 per cent in January.

The CPI report sets up a highly anticipated Bank of Canada interest-rate decision on April 10. Analysts don’t expect the central bank to change its benchmark rate from 5 per cent – the highest level since 2001 – but they’ll be looking for any hints about the timing of rate cuts.

Bank of Canada officials have been generally reticent to speak about lowering rates, highlighting their concerns around easing monetary policy too early and reigniting inflation. “It’s still too early to consider lowering the policy interest rate,” Governor Tiff Macklem said earlier this month at the bank’s most recent rate decision.

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Still, Mr. Macklem said that interest rates likely wouldn’t be lowered as quickly as they were raised over 2022 and 2023, when the bank tightened monetary policy to get a handle on inflation. Central bankers have also said that headline inflation doesn’t need to return to 2 per cent before they start cutting the policy rate.

The Canadian inflation data differ from those of the United States, where price pressures are still running hot and the economy is posting solid growth. Investors have substantially altered their interest-rate expectations in recent weeks and now predict fewer rate cuts from the Federal Reserve this year.

In Canada, rate-sensitive consumers are facing some of the highest debt payments on record, as a percentage of disposable income, while others face a payment shock when their mortgages come up for renewal. On average, consumers have reduced their spending since mid-2022, which is bringing supply and demand in the economy into better balance.

The Bank of Canada expects inflation will return to its 2-per-cent target in 2025, although it will publish new projections next month. (The bank aims for the midpoint of its 1-per-cent to 3-per-cent target range.)

Economists are split over whether the bank will begin to lower interest rates in June or July.

“Overall, we continue to expect a persistently soft economic backdrop to further slow inflation readings in Canada in the months ahead,” Royal Bank of Canada economist Claire Fan wrote in a report. This should allow the central bank “to start lowering interest rates around midyear.”

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