Money markets and economists are growing more confident that the Bank of Canada will soon cut interest rates following March inflation data this morning that showed progress on key consumer price trends.
Implied probabilities in the swaps market now show 57% odds of the bank cutting interest rates in June, up from 43% prior to the 830 am ET data, according to Refinitiv Eikon data. The odds of a cut have increased to about 84% for the July monetary policy decision, up from 72%. Money markets are pricing in a full 50 basis points of easing by this October.
Canada’s headline annual inflation rate ticked up to 2.9% in March, as expected, while core inflation measures continued easing for a third consecutive month and came in lower than Street expectations. Month-over-month, the consumer price index rose 0.6%, the largest increase since July 2023, but less than a forecast of 0.7% gain. Excluding gasoline, inflation slowed to 2.8% from 2.9% in February.
Headline inflation has now stayed under 3% since January and is still in line with the BoC’s forecast for it remain close to 3% in the first half of 2024.
The weaker-than-expected core readings immediately sparked heavy rounds of trading in bond and forex markets. The Canadian dollar fell about a quarter of a cent against the U.S. dollar to about 72.40 cents US. The Canada two-year bond yield fell about 10 basis points to 4.220%, although that’s nearly flat for the session. U.S. Treasuries, which set much of the direction for Canadian bonds, are having a quiet morning and are largely directionless so far.
The following table details how swaps markets are pricing in further moves in the Bank of Canada overnight rate, according to Refinitiv Eikon data minutes after the inflation data were released. 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 markets were pricing in monetary policy changes just prior to the data being released:
Here’s how economists and market strategists are reacting to the inflation report in written commentary:
David Rosenberg, founder of Rosenberg Research
The important point is that once mortgage payments are removed from the calculation, inflation in Canada is running at +2% on the nose. We can all be forgiven for wondering why the Bank of Canada would stay on the sidelines — can it really be because of the Fed? It would hardly be the first time that the Bank diverged from the U.S. central bank.
Let’s take a moment to step back and assess the overall inflation picture in Canada. The headline has now been within the target band for three consecutive months, even with a significant rise in energy prices in March. And if you remove mortgage interest costs (which reflect the BoC policy stance, not external price pressures), it’s at +2.0% YoY — exactly at the target midpoint. All core inflation measures, barring CPI-Trim, are in the target band too, and falling steadily. If you applied Jerome Powell’s pet “super core” services inflation index to Canada, you’d find that it stood at +2.8% in March, down from +3.4% in February. With labour markets weakening and economic activity below potential (even the Bank acknowledged recently that the economy has moved into a modest excess supply backdrop), there is little reason to think core prices will stall as they have south of the border (although the weaker Canadian dollar may provide a mild headwind in the next month or two). In short, the post-COVID-19 inflation story has run its course in Canada, and the BoC should be adjusting its stance accordingly, as it has signaled.
Charles St-Arnaud, chief economist, Alberta Central credit union
The Bank of Canada’s measures of core inflation eased further in February to their lowest level since June 2021 at 2.95%, back below the upper range of 3% of the target band.
In addition, inflationary pressures continued to narrow in March, with 15.5% of the components of CPI rising at more than 5%, compared to 21% in January, close to its historical average. Similarly, the share of components increasing by more than 3% eased to 37.5% from 41%, but still above historical norm. The decline in these measures suggests many CPI components decelerated in March and both measures are at their lowest since the summer of 2021, indicating a narrowing in inflationary pressures.
The recent trend in CPI’s monthly changes also suggests that the momentum in inflationary pressures eased in March and is again consistent with the BoC target. As such, we observe that many of the 3-month annualized changes in some key CPI components eased further but some, likely shelter, remained above 3% (+4.8%). The 3-month annualized changes in headline CPI is now at 1.3 %, after 1.8% in January.
Most importantly, the momentum of BoC’s core measures was 1.3% on average. This is the second month in a row that the momentum in the BoC’s core measure of inflation is below 2.5%. The slower inflation momentum suggests that the underlying inflation dynamic has slowed to a pace consistent with the BoC’s target.
The broad easing in inflationary pressures in March will provide some relief for the BoC. However, as we have mentioned repeatedly, in our view, the BoC is unlikely to consider cutting rates until the momentum measure for the preferred core measure returns sustainably well below 3%, meaning that its preferred measures of core inflation are below 3% and that their momentum is around or below 2.5%. This is because inflation expectations and perceived inflation remain elevated. Now that both conditions have been met, it clears the way for a cut by the BoC at the June meeting.
Derek Holt, vice-president, Scotiabank Economics
Make that three in a row! The Bank of Canada’s preferred core inflation gauges were soft again in the month of March. At the margin, that slightly added to June cut pricing. That’s welcome news after all that Canadians have been through. But we still need much more evidence. The core question of whether this is a durable soft patch remains open in my opinion.
There is a lot of ground to cover yet between now and the June meeting ... I’m not prepared to fundamentally pivot to June. On balance, the high resilience in core services pricing and ongoing suspect disinflation on the goods side of the picture makes me cautious toward declaring victory over inflation especially since it’s just three months of evidence with Spring data pending. ...
To begin easing and embolden markets to price more must have more data and developments to support it in the wake of how central banks massively misjudged inflation over recent years. If a cut follows such a soft patch then it will be very revealing of the BoC’s bias to look through inflation risk at the beginning and cut at the first whiff of softening pressures.
There is still a lot of ground to cover until the June 5th BoC meeting. April CPI arrives on May 21st and the odds of a rebound from the forces driving goods disinflation are rising at the same time that carbon taxes will factor in with implications for headline CPI and any pass through.
Q1 GDP lands on May 31st. There may be upside risk to the BoC’s forecast with growth tracking north of 3% q/q SAAR.
The Federal government’s budget that lands later today will have to be incorporated into the BoC’s forecasts at least partially before June and fully in the July MPR forecast update.
The Federal Reserve’s cuts keep getting pushed down and out. At over 1.38 to the USD the currency has lost about three cents in a week. Emboldening cuts would strongly risk CAD punching through 1.40 and stoking more import price inflation.
All the while Canadian productivity, wages and unit labour costs continue to combine to drive inflation risk. Now bring on the Spring housing market over April–June.
Olivia Cross, North America economist, Capital Economics
The March CPI data showed the third consecutive month of muted gains in the Bank of Canada’s preferred core inflation measures, suggesting that there is a growing chance of the Bank cutting interest rates at its next meeting in early June.
The Bank will not be too concerned by the modest rebound in headline inflation to 2.9%, from 2.8%, which was partly due to higher gasoline prices and also unfavourable base effects. The much more important news is that both CPI-trim and CPI-median rose by just 0.1% m/m on a seasonally adjusted basis for the third month running. That took the average annual rate down to 2.9%, within the 1-3% target range for headline inflation for the first time since June 2021. The three-month annualised rates showed an even more dramatic easing, falling to just 1.3%. Governor Tiff Macklem said at the most recent Bank of Canada meeting that “we are seeing what we need to see, but we need to see it for longer,” and the March inflation data certainly fit with the trend of downward momentum in core inflation seen so far this year. The Bank will probably want to see the same again in the April CPI data, which will be released before the Bank’s next meeting, although a modest pick-up in the average monthly gain seems unlikely to prevent a cut in June.
There are still some risks to that view, most notably the potential for a much larger rise in oil prices amid an escalation of tensions in the Middle East. Gasoline prices were one of the strongest contributors to headline CPI in March, and oil prices have continued to rise in early April. The good news for the Bank is that, thanks to more favourable base effects from here, there is scope for headline inflation to fall in the coming months despite the rise in gasoline prices so far.
Royce Mendes, managing director and head of macro strategy, Desjardins Securities
Despite the slight increase in headline inflation, a host of other measures reinforced the message that underlying price growth is normalizing. The average of the three-month annualized rates of the Bank of Canada’s core-median and trim indicators slowed to just 1.3% and the average of the year-over-year rates is down a tick to 3.0%. The Bank of Canada’s former favourite, CPIX, is now up just 2.1% over the past year. Separately, the share of components in the CPI basket that are rising more than 3%, an indicator closely watched by Governor Macklem, is down to 38% from 41%. Moreover, the share of components showing price growth of less than 1% is up to 44% from 38% in February. Both suggest that the breadth of inflationary pressures is becoming more consistent with the Bank of Canada’s 2% target.
The inflation data for March should give monetary policymakers confidence that the progress made in taming consumer price pressures is sustainable. 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. As a result, we are retaining our call for a rate cut in June. That said, cooperation from the federal government this afternoon and the next CPI release will both be key in seeing that forecast materialize.
Andrew Grantham, executive director, economics, CIBC
Inflationary pressures in Canada remain weaker and more concentrated in specific areas (shelter) than in the US, which makes sense given weaker consumer spending here. That should justify a first interest rate cut from the Bank of Canada in June, provided the next CPI release doesn’t show a sizeable reacceleration in core measures. However, a weakening currency complicates matters somewhat and could restrict how many cuts the Bank feels comfortable delivering before the Fed also starts trimming rates later in the year.
Douglas Porter, chief economist, BMO Capital Markets
Food prices are clearly calming and are now much less of an inflationary force than a year ago. In fact, grocery price inflation cooled to just 1.9% y/y from a double-digit pace in early 2023. Many of the biggest one-month declines in March were found in the grocery aisles, with fruit, vegetables, sugar and other supplies posting big drops.
It seems strange that a near-3% headline inflation result, coupled with a 0.6% monthly rise, would pass off as good inflation news these days. But the steady cooling in core inflation is welcome news indeed, with now three of the four measures of core below 3% for the first time since the summer of 2021. For the Bank of Canada, this result is likely just good enough to keep them on track for a potential trim in June. We’ll get one more CPI before that decision, as well as Q1 GDP—and today’s federal budget of course—but odds are leaning to a June move for now.
Dominique Lapointe, Director, Macro Strategy, for Manulife Investment Management
All in all, this report suggests that the re-inflation happening in the U.S. has not yet translated to Canada, leaving the institution a clear path to cut rates in June. It is also worth reminding the more precarious situation of Canadian households relative to the U.S., leaving us also anticipating more regular cuts in Canada (4) as opposed to the Fed this year.
Matthieu Arseneau and Alexandra Ducharme, economists with National Bank Financial
For their part, core inflation measures suggest that widespread disinflation continued in March. The Bank of Canada’s preferred measures of core inflation show general price weakness, with monthly increases of just one-tenth in March, following similar prints in the previous two months. Over three months, these measures are running at an annualized pace at the lower end of the central bank’s target range (CPI median at 1.1%, CPI trim at 1.4%), and we believe these measures overstate current inflationary pressures. ... The CPIX, which we believe is the most appropriate measure of the current inflationary episode as it excludes mortgage interest costs, has risen at an annualized rate of just 0.8% over this period. The data for the past three months reflect the cooling of the Canadian economy over the past seven quarters of monetary policy transmission. Despite the rebound in economic growth in the first quarter, GDP per capita is on track to contract again, continuing the downward trend that began when interest rates were first raised. Canada’s economic weakness is also reflected in a rapidly slackening labor market. Hiring is no longer keeping pace with population growth, and the weakness has been particularly pronounced in the private sector since mid-2023. And there’s no sign of a near-term rebound, with companies now much more concerned about sales than recruitment. Despite this, the Bank of Canada is maintaining an extremely restrictive monetary policy. In doing so, it risks doing too much damage to the economy, given the 6-8 quarter lag in the transmission of monetary policy to the economy.
Leslie Preston, managing director and senior economist, TD Economics
March’s inflation report marks three straight months of good news on core inflation. After appearing to stall in the latter part of last year, price pressures within the BoC’s core measures have returned to cooling. With inflation still at the top of the BoC’s range, we expect the bank will want to see a bit more confirmation before taking rates lower and lean towards a July cut. However, if the numbers continue to soften by more than we are expecting, risks are tilted towards an earlier move.
Simon Harvey, head of FX analysis, Monex Canada
With the Bank stressing that it was “looking for evidence that this downward momentum [in inflation] is sustained” before cutting rates earlier this month, today’s data suggests that June’s meeting is practically a formality at this point. The question for markets is now how fast the BoC will have to cut thereafter. Based on the sluggish momentum in underlying inflation and the fact that mortgage interest rates inflation should soon cool along with underlying mortgage rates, we suspect the BoC will have to bring the policy rate down rapidly to reflect the weaker underlying strength of the economy. In our view, should the BoC cut fewer than four times this year, there is a material risk that headline inflation may undershoot the Bank’s 2% target in 2H24. Markets are slowly converging on this view, although there remains some hesitation to fully buy into it given the more inflationary backdrop in the US and the Bank’s historic reluctance in deviating too far from the Fed with its monetary policy setting. ... We doubt markets can hold this view for much longer, however, and anticipate a further widening in [interest] rate differentials [vs the US] in Q2 as weaker Canadian data continues to contrast with signs of greater economic resilience in the US. This should see USDCAD trade higher into the 1.38-1.40 range that we anticipated for Q2, with the currency pair having already traded slightly into this range following today’s release.
Claire Fan, economist, Royal Bank of Canada
Building on two prior months of CPI reports that were both downside surprises, March’s reading today confirmed that broad-based easing in price pressures in Canada are indeed underway. Different measures of core inflation all continued to decelerate and the diffusion index that measures the scope of inflation pressures also improved again and now tracks a breadth of price pressure that’s similar to pre-pandemic. The BoC in its last meeting agreed with those developments, highlighting increased confidence that “that inflation will continue to come down gradually even as economic activity strengthens”. We continue to look for slowing inflation will allow for a first rate cut from the BoC in June.
Bryan Yu, chief economist, Central 1 credit union
While there are plenty of moving parts, we should look through the uptick in March inflation given the gasoline uptick and influence of shelter prices and underlying price pressures moderate. The Bank of Canada’s three preferred core inflation measures declined 0.1 to 0.2 percentage points, and two of the three now sit below three per cent y/y. While a touch higher than February, inflation excluding mortgage interest costs (2.0 per cent) and excluding shelter (1.5 per cent), are at or below the Bank’s target. On a trend basis, 3-month measure of headline, ex food and energy, and the Bank’s core measures all sit below two per cent. This should provide sufficient evidence for the Bank of Canada to kick start its cut cycle in June, although as we have noted, the path thereafter is unlikely to be smooth.
Darcy Keith