Wednesday’s Canadian inflation report left little doubt short-term interest rates in this country will continue to go up briskly - and money markets are now reflecting better odds of a 75 basis point hike by the Bank of Canada at its next policy meeting than 50 basis points. Some economists have also changed their forecasts, believing a 75 bps hike is on the way.
While the annual inflation rate inched down to 6.9% in September from August’s 7%, the third consecutive monthly deceleration, that was still higher than the average economist forecast of 6.7%.
When excluding food and energy, prices rose 5.4% from a rise of 5.3% in August. On the month, Canada’s consumer price index rose 0.1%, slightly ahead of forecasts that it would remain flat. Lower prices at the gas pump offset another 41-year high in food costs.
Money markets are now pricing in a 69% likelihood of a 75 basis point hike by the Bank of Canada at its Oct. 26 policy rate decision, up from about 30% prior to the data. The policy rate is seen peaking between 4.25% and 4.50% early next year, according to Refinitiv Eikon data. It now stands at 3.25%.
That expectation of higher interest rates ahead is being reflected in the bond market, where the 2-year government of Canada bond yield rose to 4.18% immediately after the data- up about 10 basis points. The closely watched 5-year bond yield, influential on the setting of fixed mortgage rates, hit a fresh 14-year high of 3.7% - up nearly 20 basis points. (The rise in bond yields not only reflected Canada’s inflation data, but also a jump in U.S. Treasury yields on Wednesday).
Here’s how economists and market strategists are reacting to the inflation report:
Douglas Porter, Chief Economist, BMO Capital Markets:
Bluntly, inflation did not ease as much as anticipated last month, even as gasoline costs took a big step back. Underlying inflation remains extremely persistent and sticky at above 5%. Combined with the BOC’s recent tough rhetoric, the recent weakness in the Canadian dollar, and the strong likelihood that the Fed hikes by 75 bps at the next FOMC, we are now expecting a like-sized 75 bp hike next week from the Bank. This would take the overnight rate to 4.0%, and we suspect that will not be the end of it—pencilling in a 25 bp move in December.
Stephen Brown, Senior Canada Economist, Capital Economists:
The Bank’s core CPI inflation measures were unchanged in September but, given that we expected a decline due to more favourable base effects, that probably increases the odds of another 75bp hike next week, particularly when households near-terms inflation expectations have risen further.
The monthly acceleration in non-food and energy prices, together with the unchanged annual rates of CPI-median, CPI-trim and CPI-common, means that the Bank is still yet to see “clear evidence that underlying inflation has come down”, as Macklem stressed in his speech earlier this month. With Macklem also warning us about elevated consumer inflation expectations, and the data this week showing that housing starts in the apparently interest rate-sensitive construction sector surged in September, the data this week lead us to think that the Bank is likely to press on with a 75 bp hike next week, rather than drop down to a 50 bp move.
Karyne Charbonneau, executive director, Economics, CIBC Capital Markets:
There will be some long faces at the Bank of Canada this morning as inflation cooled less than in expected. Unadjusted headline CPI increased 0.1% in September, with the annual rate easing only one tick to 6.9% (consensus -0.1%, 6.7% y/y). This is the third consecutive deceleration in headline CPI driven mainly by the fall in gasoline prices. Given that those prices have since reversed, the next month could see headline inflation temporarily heading in the wrong direction again. Meanwhile, food prices continued to rise at a historic pace. But that is not the main focus for the Bank of Canada, who is paying closer attention to core inflation. CPI excluding food and energy rose by 0.4% seasonally adjusted on the month, faster than last month and a pace too high to be consistent with the 2% target, but still an improvement from earlier in the summer.
The Bank of Canada has clearly not slayed the inflation dragon yet and is therefore set for another large rate hike next week. The pace of growth in seasonally adjusted inflation excluding food and energy picked up by more than expected this month and is too high for comfort. As such, we now believe the Bank will need to go with a 75 bps hike next week rather than the 50 bps we previously anticipated. The Bank might then be left with a last 25 bps in December if growth numbers support it.
Matthieu Arseneau and Alexandra Ducharme of National Bank Financial:
September’s inflation data was disappointing. Indeed, after a welcomed calm in August, price growth picked up in September. Economists were expecting gasoline prices to fall, but did not foresee the dramatic jump in food prices. Let’s hope that rumors of a price war among major grocery chain will contribute to calm down this critical expenditure for Canadians. Housing was also a major contributor to price increases this month, with mortgage interest cost rising by 2.5%, the largest increase since 1971. Since the central bank is responsible for this development, it is interesting to note that this component increased monthly headline inflation by roughly 0.1%. Nevertheless, gains were widespread in September as evidenced by CPI-Median and CPI-Trim increasing 0.27% and 0.35%, a pace that, when annualized, stands above the Bank of Canada’s target range.
It turns out that we must not be overly influenced by the volatile monthly movements and perhaps look at the recent trend which remains encouraging for the Bank of Canada. Back in July, Bank of Canada expectations for Q3 headline annual inflation was at 8.0%, it finally came out 8 ticks lower (7.2%). There is also downside risk to the 2.0% annualized growth the central bank was expected for the quarter given the evolution of the economy since then. Those positive developments on the inflation front and on the pace of the economy which has moderated significantly suggest less acute price pressures in the coming months and that monetary tightening could be less aggressive than it is south of the border.
Derek Holt, Head of Capital Markets Economics, Scotiabank Economics:
Hot underlying details to Canada’s CPI update for September reinforce my expectation for the Bank of Canada to hike its policy rate by another 75bps next week alongside a still hawkish bias that repeats guidance that rates will still need to move higher. ... I don’t think the BoC has a choice to hike by less than 75bps. ... All core CPI measures were hot... I think the BoC still needs to appear hawkish and then be open to pivoting later if needed. Unlike Australia, Canada has much firmer trend wage growth, greater attachment to the Fed, ongoing Fed/prov stimulus from Trudeau bucks to Ontario licence refunds to Quebec’s vote bucks etc etc, diff commodities, less direct exposure to China, fresher and firmer inflation readings, a job market is still incredibly tight etc. ... If the BoC hikes 75bps next week then they probably have a terminal rate in mind that is in the ballpark of what the FOMC has guided for theirs (4.5-5%). It’s hard to imagine that after a 75bps hike they either stop or downshift to just a 25bps and then perhaps done.
Leslie Preston, Managing Director & Senior Economist, TD Economics:
It is great that headline inflation took a small step in the right direction in September, but underlying inflation pressures in core measures showed no signs of cooling down. The BoC has hiked interest rates 300 basis points so far this year, and the impact of that is starting to be felt in the economy, from housing to consumer spending. But, with the Bank of Canada’s (BoC) core measures of inflation more than 2 percentage points from the target range of 1-3%, more cooling in demand is required. Today’s report emphasizes the need for a hefty 50 basis point hike next week in the BoC’s overnight rate. We expect the bank is getting closer to a pause on rate hikes, once it reaches 4% by the end of the year.
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Darcy Keith