Canada’s Inflation Hits 2% Target, Sparks Rate Cut Hopes

Canada’s annual inflation rate reached the central bank’s target of 2% in August, according to data released on Tuesday. This has raised hopes for a 50-basis-point interest rate cut by the Bank of Canada (BoC) next month.

Statistics Canada reported that the consumer price index (CPI) saw its smallest increase since February 2021, and key core price measures also dropped to their lowest levels in 40 months. On a month-to-month basis, consumer prices fell by 0.2%.

Royce Mendes, head of macro strategy at Desjardins Group, suggested that the central bank is likely to reduce its policy rate by 50 basis points next month to help return to a more neutral interest rate environment, which is between 2.25% and 3.25% in Canada. This neutral rate is where interest rates neither hinder nor boost economic growth.

Analysts had expected the CPI to decrease to 2.1% from 2.5% in July on an annual basis, and to remain steady month-over-month. At a recent monetary policy meeting, BoC Governor Tiff Macklem indicated that the central bank is increasingly wary of inflation falling below its target due to weak economic growth.

Canada’s economic growth has been slowing, with projections for the third quarter GDP now expected to fall to half of what the BoC previously forecast. Unemployment has also dropped to a seven-year low, not counting the pandemic years of 2020 and 2021.

Randall Bartlett from Desjardins noted, “The gradual rise in the unemployment rate and slowing economic growth suggest that high interest rates are effectively cooling the economy, maybe even too much.” He also predicted a 50-basis-point cut at the BoC’s October meeting.

The BoC has already cut its key policy rate three times in a row, lowering it by a total of 75 basis points to 4.25%. Money markets are anticipating 25-basis-point cuts at the last two monetary policy meetings of 2024, with expectations for a 50-basis-point cut next month increasing slightly after Tuesday’s data release.

The decrease in inflation was mainly driven by falling prices for gasoline, phone services, and clothing. However, shelter costs, which include mortgages and rents, continued to rise slowly. The Canadian dollar fell to C$1.3589 against the U.S. dollar (73.59 U.S. cents).

The BoC had initially predicted an annual inflation rate of 2.6% this year, dropping to 2.4% next year, before reaching the midpoint of its target range (1-3%) by 2026. The CPI-median, which measures the average price change, slowed to 2.3% in August from 2.4% in July. The CPI-trim, which excludes extreme price changes, decreased to 2.4% from 2.7%.

Gasoline prices were the biggest contributor to the inflation drop, falling by 5.1%, while clothing and footwear prices decreased by 4.4%. In contrast, shelter costs, making up nearly 30% of the CPI basket, increased by 5.2% in August, down from 5.7% in July, primarily due to rising mortgage interest and rent costs. Mortgage interest rates slowed to 18.8% in August from 21% in July, while rent increased to 8.9% from 8.5%.