What Does Canada's Inflation Rebound to 2.0% Mean for the Bank of Canada?

Canada's 12-month inflation rate rebounded to 2.0% in October, slightly above market expectations, from 1.6% in September, its lowest level in more than three years.

Goods prices edged up 0.1% year-over-year after contracting 1.0% in September, while services rose 3.6%, their smallest 12-month gain since January 2022.

Just as in September, much of the story was energy related: Gasoline prices fell just 4.0% year-over-year after a much larger 10.7% drop the month before. Nonetheless, gasoline prices remained the top downward contributor to the 12-month CPI. Overall energy prices were up 0.3 percent on the month and down 3.5% from October 2023.

Source: Statistics Canada

Excluding gasoline prices, the 12-month inflation rate was stable at 2.2% for the third consecutive month.Half of the eight main CPI categories were up from a year earlier, led by shelter, health and personal care, as well as food and alcohol and tobacco.

Housing-related items were once again the top contributors to the 12-month price appreciation, led by a nearly 15% rise in mortgage interest cost.

Source: Statistics CanadaDespite the ongoing upward pressure from shelter price, today's data confirm a slowing trend.

The recent slowdown in shelter inflation has played a key role in the cnetral bank's confidence that inflation was heading in the right direction. A reversal of this trend would be a source of concern.

While both the mortgage interest cost and rent increases have been slowing, property taxes and other charges picked up to 6.0% year-over-year, their highest rate in more than three decades (1992).

Assessed yearly, property taxes depend not only on the value of the property, but also on provincial tax rates, charges levied by municipalities for specific services such as wastewater and garbage collection,and homeowner tax rebates.

All-in-all, however, shelter, a key component of core inflation, is trending the way the central bank wants.

The Bank of Canada's own three core measures averaged 2.4% in October, up 0.1 percentage point from September, less than the 0.4 percentage point gain in the headline CPI index.

Prices excluding food and energy - another measure of core inflation - were up 2.3% in October, down from 2.4% in September.

In other words, the jump in the headline inflation isn't matched by a jump in core inflation, which means it isn't jeopardizing the longer-term BOC's scenario.

While October's CPI report reflected a jump in the headline index, it is currently at the 2% target. Much of the increase is related to base effects and the volatile energy component. This means the central bank will likely look through this jump to assess the trend. Besides, October's 2.0% inflation is consistent with a projected fourth quarter average of 2.1%.

Yet the case for a 50-basis point rate cut in December has diminished, especially given the recent upward revisions to annual GDP growth estimates. Statistics Canada now estimates that activity expanded 1.5% in 2023, an upward revision from 1.2%. What this means is that the Canadian economy has been more resilient than had been assumed. The BOC's current growth projections are based on a 1.2% GDP growth in 2023.

But as Bloomberg pointed out, the revisons were led by business investment, implying a higher growth potential.

Against this backdrop, the central bank might want to take the middle of the road with a 25 basis-point rate cut, especially since the minutes of its October meeting indicate that some of the Governing Council members worried that a 50-basis point rate cut could send the message that the economy was in trouble.

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