Market reaction has been subdued to today’s Canadian CPI data, reflecting the fact the headline number came in as expected and there’s little in the report to shake up views of where monetary policy is heading.
Canada’s annual inflation rate fell to 3.1 per cent in October from 3.8 per cent in September. Some core readings of inflation came in slightly lighter than the Street consensus but nothing that sparked a lot of repositioning in money markets.
The Canadian dollar barely budged, keeping within the North American morning trading range of between 72.78 cents US and and 73 cents US, not much change on the day. It’s a similar case in bonds. The Canada two-year bond yield, which is particularly sensitive to Bank of Canada monetary policy moves, is up about 3 basis points but well within the day’s trading ranges. The Canada five-year is up about 5 basis points. Those moves in yields had a little more upward momentum than their U.S. counterparts after the data release, which suggests markets don’t view the inflation numbers as particularly dovish.
Implied interest rate probabilities in swaps markets aren’t showing much change in the wake of the data, either. Traders there are pricing in at least a 25 basis point cut in the Bank of Canada’s overnight rate by June of next year. By December of next year, money markets are pricing in 75 basis points of cuts.
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 910 am. 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 830 am. ET inflation report:
This has probably been the most subtle reaction to Canada inflation data that we’ve seen in many months, and markets are signalling that traders don’t see any changes in the Bank of Canada overnight rate for at least the next few meetings. And they are pricing in minimal risk of any further hikes.
Here’s how economists are reacting:
Royce Mendes, managing director and head of macro strategy, Desjardins Securities
Canada continues to see slow and steady progress in its battle to tame excess inflationary pressures. The headline price index rose just 0.1% in October after declining 0.1% in September. That was in line with the consensus view and left the annual rate of inflation tracking 3.1%, down from 3.8% in the prior month. Base effects, falling energy prices and tepid food price growth all helped restrain inflation in October. Excluding food and energy, prices were up a more robust 0.3% in seasonally-adjusted terms, which saw the annual rate of that measure accelerating two ticks to 3.4%.
That said, much of what’s driving excess inflation in that traditional core inflation indicator is attributable to shelter prices. Those pressures are being driven by longstanding housing supply issues which are pushing up rents and higher mortgage interest costs. Prices excluding food in stores, energy and shelter remained running at a year-over-year pace of just 2.0%. That indicator is a better reflection of the prices that monetary policy can control.
The Bank of Canada’s preferred measures of core inflation also looked cooler in October. The three-month annualized rate of core trim and median stood at 3.2% and 2.7%, respectively. Both readings were materially slower than the pace registered in September.
This is exactly the type of progress that central bank officials have been waiting to see. If the door wasn’t already shut to additional rate hikes, it now should be. The market hasn’t moved much on the numbers, with yields lower before the data were released. However, looking at the core readings, we believe there’s more progress than initially meets the eye in the headline numbers. We continue to see room for shorter term bond yields to fall further.
Stephen Brown, deputy chief North America economist, Capital Economics
There was good news all round in the October CPI report, with the overall CPI falling in month-on-month seasonally adjusted terms for the first time since May 2020, and the average three-month annualised change in CPI-trim and CPI-median falling to 3.0%, the lowest since early 2021. With gasoline prices falling further this month and the economy already seemingly in recession, we expect headline inflation to fall to 2.0% by the third quarter of next year. ...
The most encouraging part of the report was that CPI-median rose by just 0.1% m/m again. Although the monthly change in CPI-trim edged up to 0.2% m/m, those results still confirm that the rise in core inflation pressures over the summer was due to temporary factors. With gasoline prices falling further in recent weeks, headline inflation is on track to drop below 3% this month, and weak economic growth should mean that CPI-trim and CPI-median inflation continue to fall from their average annual rate of 3.6% in October.
Leslie Preston, managing director and senior economist, TD Economics
It is encouraging to see another leg down in CPI inflation in October, but the Bank of Canada will likely need to see further progress on core inflation before it feels confident that inflation is headed back to the 2% target. There is little doubt that Canada’s economy has cooled in recent months, but the chill in inflation that should follow is proving slow to show up. We expect weaker demand in the economy will ultimately dampen price pressures, but given tightness in the labour market, it will take time.
This presents a communication challenge for the Bank of Canada. The objective of monetary policy in Canada is to keep inflation “low and stable” and progress on meeting its target has been slow despite aggressive rate increases. Fortunately, we won’t need to wait long to get the Bank’s latest thinking on inflation, with Governor Macklem slated to speak on “The Cost of High Inflation” tomorrow in Saint John. We’d expect the Governor to emphasize for Canadians why the Bank is laser focused on wrestling inflation back to target, even though the process is painful.
Douglas Porter, chief economist with BMO Capital Markets
In seasonally adjusted terms, prices fell 0.1%, the first such decline since the opening months of the pandemic in 2020. This was a snick below consensus expectations, and even a tad better than the benign U.S. result a week ago. The details were roughly in line with expectations, with food and gasoline soft, and core almost right on our calls. Food fell for a third straight month (in unadjusted terms), trimming the annual inflation rate for groceries to 5.4% from 5.8% the prior month and less than half the early year peak of 11.4%.
It wasn’t all good news, however, as services generally remain sticky. On the strong side, we saw both shelter and recreation, education & reading jump 0.9% m/m. Shelter was driven by a 1.4% surge in rent (the biggest monthly rise most since 1983), which fired up the annual rate almost a full point to 8.2%. As well, there was yet another chunky 2.5% rise in mortgage interest cost, leaving them up a towering 30.5% y/y. October is the month when annual property tax changes are captured, and this year saw a meaty 4.9% rise, up from 3.6% in 2022. This large increase will linger in the inflation rate for a full year. For recreation, travel services and recreational vehicles were very firm.
Bottom LIne: While no one expected inflation to go quietly into the night, this is a generally good news step in the right direction. Note that three provinces now have an inflation rate below 2%, while only three are above 3%, so much of the country is already seeing serious signs of stabilization. (Unfortunately, the two largest provinces have the fastest inflation rates—Quebec at 4.2%, Ontario is at 3.3%). Overall, today’s result drives home the point that there is no need for further BoC tightening, especially with the economy already struggling to grow at all and underlying inflatio calming. However, before the Bank can even begin seriously considering rate relief, we’ll need to see more evidence that services inflation is also moderating—that could be at least another six months down the road.
Sal Guatieri, senior economist with BMO Capital Markets
Regardless of which of the many ‘core’ measures of Canadian inflation you pick, the main theme is one of renewed moderation after a summer stumble. Run rates for three popular measures (Trim mean, Median, and total ex-food and energy) averaged 3.5% on a yearly basis in October and 3.1% on a shorter-term (3- and 6- month) basis. Even better, simply omitting the eight most volatile items (largely several food and energy goods and that real pressure cooker, mortgage interest costs) yields 2.7% and 2.2%. Even more impressive is that this measure includes residential rent, which has accelerated on notorious supply challenges in the face of torrid population growth. There’s not much the Bank of Canada can do about that. But the progress of core inflation, and the utter lack of headway for the economy, means it likely can stop raising rates.
Derek Holt, vice-president, Scotiabank Economics
Canada is in a soft patch for inflation but let’s not get carried away. ... We have two months of evidence across two of the three main core inflation measures and there are still worrisome underlying details to emphasize. For now, it’s encouraging, but we’re a long, long way from the BoC pulling out the pom-poms. To do so would be like the Blue Bombers declaring victory in the Grey Cup twelve seconds before the end of the Grey Cup. There is still of game left here folks. ...
So far we can say that while the various measures somewhat conflict with one another, on balance Canada continues to make progress toward lower inflation. We’re not there yet. It’s two months of a soft patch using the measures that look at higher frequency estimates of underlying price pressures at the margin, but we’re closer. The suite of these measures continues to trend somewhat above the 2% gauge and we need to see further evidence of disinflationary pressures.
I think the BoC will continue to require much more evidence that this soft patch has more legs to it than just a couple of months. They will also focus upon the underlying details and the risks going forward.
Key to goods inflation will be what happens through the holiday shopping season. Will discounting be more/less/same as prior seasons? How will holiday shopping perform after an extended period of flat trending retail sales that are entirely skewed toward goods? ... In short, at this rate of service inflation and its persistence, we’d better hope goods inflation never gets reignited. I’m skeptical and think this is a temporary soft patch on the latter. ... The last thing in the world that the BoC would wish to do would be to add even further and more sustained upward pressure upon shelter-related inflation and its potential spillover effects by easing prematurely. They may not target housing explicitly, but hot housing and service price inflation will keep them very guarded for a long while yet.
Bryan Yu, chief economist with Credit 1 credit union
October’s rapid downshift in inflation adds to a drumbeat of weaker economic data that should keep the Bank of Canada on the sideline at its December 6 meeting. Economic data has stagnated. Gross domestic product is trending flat, with per capita GDP in outright decline, and a cooling labour market, albeit with more robust wage growth. Conditions are expected to worsen going forward as past Bank of Canada hikes continue to impact activity and mortgage renewals through 2024 further lead consumers and businesses to retrench. We expect the Bank of Canada to cut rates late in the second quarter of 2024 provided inflation continues to ease and wage growth abates.
A risk to easing inflation and rate cuts remains the impact of shelter costs on inflation. Rate cuts will automatically reduce some of this pressure, but rents will remain under upward pressure due to insufficient supply that requires more than monetary policy to fix. Federal and provincial government policies to drive higher affordable supply will take years to impact the market. As a result, the Bank may be forced to look through shelter impacts in its monetary policy decisions.
Katherine Judge, director and senior economist with CIBC Capital Markets
Looking at the Bank of Canada’s preferred measures of inflation, both CPI-trim and median decelerated (to 3.5% y/y and 3.6% y/y, respectively), suggesting that price increases are becoming more concentrated, namely in mortgage interest costs. Looking ahead, a weak economic backdrop should work to limit prices further in these measures, and could allow the BoC to start cutting rates as early as Q2 next year.
Simon Harvey, head of forex analysis at Monex Europe and Canada
In conjunction with data showing slack building within the labour market and growth data suggesting the economy is in a shallow recession, today’s constructive inflation report has completely undermined the BoC’s hawkish bias. This is yet another confirmatory point for our view that the BoC, having led the Fed during the hiking cycle, will once again be the pace setter in the 2024 easing cycle, with a cut likely as early as April. Markets have been slowly aligning with this view in recent weeks, which has seen the Canadian dollar lag the G10 rally amidst the softer dollar environment.
Claire Fan, economist with Royal Bank of Canada
Details in today’s inflation report showed further moderation in domestic price pressures in Canada, extending a downside surprise in price growth in September. Not only were the readings themselves lower among many components, the scope of inflation has also continued to narrow. The share of consumer basket (excluding shelter) that was seeing near-term inflation at above 5% annualized rate fell below 35% in October, still higher than the approximately 20% share in pre-pandemic 2019 and was just half of the peak share of 70% over early summer of 2022. Ongoing signs of deterioration in consumer spending and labour market conditions support our outlook for inflation to keep moderating in the quarters ahead. We continue to expect the BoC is done with rate hikes, and for them to cautiously pivot to cuts over the latter half of 2024.
Stéfane Marion, chief economist and strategist with National Bank
In its most recent Monetary Policy Report, the Bank of Canada stated that “unlike in previous cycles, rising mortgage interest costs are not mitigated significantly by weakness in other shelter components”. This was again evident in the just released CPI report, which showed that annual rent inflation jumped 8.2% in October, the highest level in over 40 years. Recall that Canada’s record housing supply imbalance, caused by an unprecedented increase in the working-age population (874,000 people over the past twelve months), means that there is currently only one housing start for every 4.2 people entering the working-age population, a 5 standard deviation from the historical ratio of 1 housing unit started for every 1.8 people. Under these circumstances, people have no choice but to bid up the price of a dwindling inventory of rental units. The current divergence between rental inflation (8.2%) and CPI inflation (3.1%) is the highest in over 60 years. ... There is no precedent for the peak in rental inflation to exceed the peak in headline inflation. Unless Ottawa revises its immigration quotas downward, we don’t expect much relief for the 37% of Canadian households that rent.
Arlene Kish, director, Canadian Economics, S&P Global Market Intelligence
October’s inflation details, especially for services prices, are a concern. Inflationary pressures fears can spark anew if energy prices drift higher and services inflation does not cool. Therefore, the possibility of the Bank of Canada tightening monetary policy is not completely gone, but the probability has been severely reduced. The Bank of Canada will hold rates steady at next month’s policy announcement. It is too soon to expect an interest rate cut. S&P Global Market Intelligence anticipates inflation to dip below 3% in November.
Darcy Keith