Canada’s Inflation Cools, Sparking Speculation of Rate Cuts

In a surprising turn of events, Canada witnessed a slowdown in inflation during February, marking its most subdued pace since June. Core inflation indicators also dipped to over two-year lows, prompting speculation among investors for a potential rate cut come June.

According to data released on Tuesday, annual headline inflation retreated to 2.8% last month, surpassing analyst projections for a 3.1% increase and falling below January’s 2.9% uptick. Meanwhile, the consumer price index recorded a modest 0.3% rise on a monthly basis, falling short of the forecasted 0.6% surge, as reported by Statistics Canada.

This unexpected downturn in inflation prompted a notable shift in market sentiment, with money markets revising their expectations for a 25 basis point rate cut in June to over 75%, up from 50% prior to the release of the inflation figures. Additionally, the likelihood of an April rate cut surged to over 28% from 18% pre-data.

Royce Mendes, head of macro strategy for Desjardins Group, emphasized the expectation for a more dovish stance from central bankers in April, laying the groundwork for a potential rate-cutting cycle starting in June.

The repercussions of this inflation slowdown were felt in the currency and bond markets, as the Canadian dollar depreciated to a three-month low against the US dollar, while Canadian government 10-year bond yields experienced a notable decline.

Key contributors to the inflation deceleration included softer price growth in food purchased from stores, alongside reductions in prices of cellular plans and internet services, according to Statscan. Notably, the rise in grocery prices eased to 2.4%, marking the first instance since October 2021 where it lagged behind headline inflation.

However, analysts cautioned against delaying a rate cut, stressing the potential adverse effects on the economy. Simon Harvey, head of FX analysis at Monex, warned that delaying a decision until June could result in the Bank of Canada playing catch-up with economic conditions in the latter half of the year.

While Canada experienced a divergence in data compared to its US counterpart, with the Federal Reserve witnessing a surge in consumer prices for February, the Bank of Canada’s preferred measures of core inflation dipped to their lowest levels in over two years.

Looking ahead, the Bank of Canada remains vigilant for sustained evidence of downward momentum in underlying inflation, with its next rate announcement scheduled for April 10. The bank’s decision-making will be guided by its projections, with January forecasts anticipating headline inflation to hover around 3% in the first half of 2024 before moderating to 2.5% by year-end.

Despite the bank’s previous rate hikes aimed at curbing inflation, the recent slowdown underscores the delicate balancing act facing policymakers as they navigate Canada’s economic landscape amidst evolving inflationary pressures.