News & analysis

As we documented in our latest Week Ahead, major macroeconomic indices out of Canada have been subject to an incredible amount of noise lately, leading most indicators to overstate the strength of the economy and the degree of inflation.

The sheer amount of inflation indicators derived by the BoC has only amplified the level of uncertainty over the true state of the economy too, with measures like the 3-month annualised rate of core inflation jumping back up above 3.5% at year-end, even while the 3-month annualised rate of headline CPI ex shelter tracked in outright deflation. This has made the readthrough to the Bank of Canada’s easing cycle relatively opaque and posed the biggest risk to our view that the central bank would begin easing policy at its April 10th meeting.

Thankfully for the BoC, January’s inflation data presented a much clearer picture of disinflation, with all indices essentially reflecting weaker growth rates now weighing on price pressures.

Headline inflation fell from 3.4% at the end of last year, to 2.9% YoY,  with disinflation visible across all major aggregates. This delivered a considerable downwards surprise on expectations, which foresaw only a marginal deceleration to 3.3%, and contrasted sharply with inflation data out of the US, which last week showed renewed strength due to annual price resetting and technical factors. On a monthly non-seasonally adjusted basis, price growth was flat at the start of the year too, piggybacking on a -0.3% reading in December and undershooting expectations for a 0.4% rebound. Unlike December, however, the weaker monthly reading didn’t just reflect gasoline prices as recreation (-0.7%) and clothing and footwear (-1.8%) prices also fell on the month. While some may point to the fact that core inflation rose by 0.1% on the month as a whole, the increase was actually much weaker at 0.07% on an unrounded basis. Furthermore, the data does little to derail the overall trend in core inflation, with the 6-month annualised rate now falling to 2%.

BoC’s 3-month annualised rates of core inflation renew their decline after spiking towards the end of last year

Looking at other measures of core inflation, disinflation progress was also visible. The BoC’s CPI-trim and CPI-median measures both fell on the year from 3.7% and 3.5% to 3.4% and 3.3% respectively, while the average 3-month annualised rate of the two fell back from 3.63% in December to just 3.22%. In fact, on a monthly basis, the increases in the core measures were so soft at just 0.1% and 0.14% respectively, that even a rebound to 2023’s average monthly pace of price growth would see the 3-month annualised rate continue to decline to 3% by the end of Q1. Given the economy is now operating at a much lower growth rate and is subject to increasing levels of slack, the true pace of disinflation is likely to be much quicker. Stripping out housing costs paints an even starker picture, with price growth on 3mma annualised basis dropping deeper into outright deflation, and now well below target even when looking at YoY figures.

This is particularly notable given the recent attention this has garnered from BoC policymakers, a factor we suspect indicates a dawning realisation on the Governing Council that the need for cuts is growing imminent. To highlight our point, even the breadth of inflation pressures is now narrowing. The share of the CPI basket tracking above 3% on the year is now just 46%, down from 79% this time last year.

Headline and core inflation ex-shelter components are also tracking in deflationary territory 

With the inflation data now starting to support our view that weak growth conditions are finally starting to weigh on firms’ pricing power, leading inflation data to align with businesses’ inflation expectations and hiring intentions, markets are now coming back around to the idea of the BoC easing rates earlier than June.

While March’s meeting comes too quickly given there are no further major data releases to corroborate today’s weaker inflation data beyond the lagged Q4 GDP report, April’s meeting is once again live. Should today’s constructive inflation report be confirmed by the next two jobs reports and February’s inflation data, we think the BoC will commence its easing cycle on April 10th, as per our long-held base case. Pricing of this remains too low, in our view, even as the implied probability of a rate cut in early Q2 has risen from 30% to just north of 50% following today’s data.

As it starts to become clearer that the BoC will ease before the Fed in the coming weeks, we expect a re-widening in rate differentials to unlock further upside in USDCAD, leading the pair back above the 1.36 handle to pre-December Fed levels.

 

Authors:
Simon Harvey, Head of FX Analysis

Nick Rees, FX Market Analyst

 

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