Canada looks increasingly set to lower interest rates before the United States and embark on a divergent path for monetary policy for at least a short period, owing to weaker price pressures north of the border.
In Canada, the Consumer Price Index rose 2.9 per cent in March from a year earlier, Statistics Canada reported on Tuesday. While inflation ticked up from 2.8 per cent in February, this outcome was widely anticipated by analysts because of higher gasoline prices. Several measures of core inflation – which strip out volatile components of the CPI – continued to slow in March.
“Measures of core inflation did tick down again and that does suggest that underlying inflationary pressures are continuing to ease,” Bank of Canada Governor Tiff Macklem said at an event in Washington on Tuesday. “We continue to be moving in the right direction.”
Mr. Macklem spoke alongside his American counterpart, Federal Reserve chair Jerome Powell, who struck a different tone about the path of inflation in the U.S.
Read more: How economists and market bets for rate cuts are reacting to today’s inflation data
The Fed has maintained that it needs “greater confidence that inflation is moving sustainably toward 2 per cent before it would be appropriate to ease policy,” Mr. Powell said at the event hosted by the Wilson Center, a think tank.
“The recent data have clearly not given us greater confidence and instead indicate that it’s likely to take longer than expected to achieve that confidence,” he added.
The Canadian economy has stumbled in recent months as it contends with a benchmark interest rate of 5 per cent, the highest in more than two decades. While the U.S. has even higher interest rates, its economy is still growing at a rapid clip and inflation has recently picked up again.
After the Statscan report, traders ramped up their bets that the Bank of Canada will start to lower interest rates in June. If not then, July is considered a certainty. Investors aren’t expecting the Fed to make its first move until the September or November meetings.
A divergent path for interest rates would likely weaken the Canadian dollar, relative to the greenback. This would be helpful for exporters, but it would also raise the cost of imported goods.
“A weakening currency complicates matters somewhat and could restrict how many cuts the Bank [of Canada] feels comfortable delivering before the Fed also starts trimming rates later in the year,” Andrew Grantham, senior economist at CIBC Capital Markets, said in a client note.
At last week’s monetary policy decision, where the Bank of Canada held rates steady, Mr. Macklem said he was encouraged by the recent easing of inflation, but that he wanted to see the trend play out for longer before the bank starts to lower rates. If the bank cuts too soon, inflation could flare up again, he warned.
Gas prices rose nearly 5 per cent in March, month over month, and they’ve increased further in April. Another challenge is shelter prices, which rose 6.5 per cent in March, year over year. Rents jumped by 8.5 per cent, a symptom of long-standing housing shortages across the country.
But other areas were tamer in Tuesday’s report. Food purchased from stores rose at an annual rate of 1.9 per cent in March, down from 2.4 per cent in February. Grocery inflation had peaked at more than 11 per cent in late 2022 and early 2023.
Several bespoke measures of inflation are subsiding. On a three-month annualized basis, the Bank of Canada’s preferred measures of core inflation are now running below 1.5 per cent.
As of midday Tuesday, markets were pricing in a 75-per-cent chance that the Bank of Canada cuts rates by a quarter-point in June, up from 60 per cent on Monday, according to Bloomberg data.
Over 2022 and 2023, the Bank of Canada hiked interest rates to 5 per cent from pandemic lows of 0.25 per cent. This tightening of monetary policy is intended to curb demand in the economy and bring inflation back to the central bank’s 2-per-cent target. Because monetary policy affects the economy with a lag, the Bank of Canada doesn’t have to wait for inflation to return to 2 per cent before it starts to lower interest rates.
Mr. Macklem said last week that the decline in core inflation has been “very recent.” The central bank needs to see more evidence that it’s “not just a temporary dip,” he added.
Several analysts said Tuesday’s report offered plenty of additional evidence that inflation is moving sustainably back to target. The next CPI report will be published on May 21, giving the Bank of Canada another set of numbers to consider before its highly anticipated decision in June.
“The inflation data for March should give monetary policymakers confidence that the progress made in taming consumer price pressures is sustainable,” Royce Mendes, head of macro strategy at Desjardins Securities, said in a client note. “When Macklem said he wanted to see more of what he had seen in January and February, this type of release was exactly what he was looking for.”
Matt Lundy