Core inflation puts pressure on Bank of Canada to raise interest rates again

Canada’s inflation rate eased slightly in November but there were signs that underlying price pressures in the economy remain strong, increasing the odds that the Bank of Canada moves ahead with another interest-rate increase in January.

The Consumer Price Index rose 6.8 per cent compared with the previous year, as lower prices at the gas pump offset an acceleration in grocery prices and rent costs, Statistics Canada reported Wednesday. That’s down from 6.9 per cent in October, although slightly ahead of economist expectations of 6.7 per cent.

The rate of inflation has trended down since peaking near a four-decade high of 8.1 per cent in June. But key measures of core inflation, which strip out volatile food and gasoline prices, continued to rise in November. That suggests the economy is still running hot in the face of multiple interest-rate hikes, and makes it more likely that the Bank of Canada will raise rates at least one more time next month.

“Turning the temperature down on inflation is proving to be an achingly slow process, and we suspect this may be a theme for 2023,” Bank of Montreal chief economist Doug Porter said in a note to clients.

After raising interest rates seven consecutive times to tackle inflation, the Bank of Canada said this month that it’s considering halting further moves. Whether that happens at its next meeting on Jan. 25 will depend on incoming economic data, central bank officials have said. The bank has a target of 2-per-cent annual inflation.

“While lower pump prices will help chop next month’s rate, the fact that many measures of core inflation are still nudging higher is a clear warning sign of persistent underlying pressures,” Mr. Porter said. “We are leaning to the view that the Bank of Canada hikes rates one more time in January to 4.5 per cent, and this firm report does nothing to doubt that call.”

Financial markets are now pricing in a roughly 60-per-cent chance that the central bank will announce another quarter-point rate hike in January.

Higher interest rates make it more expensive for households and businesses to borrow money, with the goal of lowering spending throughout the economy and slowing the pace of price increases. However, interest-rate changes work with a lag – often 18 to 24 months – making it difficult for the central bank to assess the impact of its policies in real time. That creates the risk that the bank will overtighten monetary policy and do unnecessary damage to the economy.

There are signs that inflation is trending in the right direction. On a monthly basis, the CPI rose 0.1 per cent compared with a 0.7-per-cent gain in October.

Canadians got a break at the gas pump in November, aided by the reopening of several oil refineries in the Western United States, Statscan said Wednesday. On a monthly basis, gas prices were down 3.6 per cent in November, after a 9.2-per-cent jump in October.

Since peaking in June in the wake of Russia’s invasion of Ukraine, falling global oil prices have helped drag down inflation in Canada. That said, the price of gasoline was still 13.7-per-cent higher in November than a year earlier.

There was little relief at the grocery store in November, where prices were up 11.4 per cent compared with the previous year – a bigger annual jump than in October.

Chicken prices were up 9.3 per cent compared with the year before, partly because of reduced global supply after an outbreak of avian influenza, Statscan said. Coffee and tea prices were up 16.8 per cent, while cereal prices rose 15.7 per cent.

Food price inflation has proved tough to tackle. Bank of Canada deputy governor Sharon Kozicki noted in a speech earlier this month that food prices “have continued to increase despite most agricultural commodity prices being well below their pandemic highs.”

Canadians also paid more for shelter in November. Homeownership expenses have marched higher as the Bank of Canada has raised interest rates and an increasing number of homeowners have renewed their mortgages. Mortgage interest costs were up 14.5 per cent in November compared with the previous year, the largest increase since 1983.

Meanwhile, rental prices rose by 5.9 per cent year over year, compared with a 4.7-per-cent increase in October, with the biggest jumps seen in Prince Edward Island, British Columbia, Quebec and Ontario.

Statscan noted that higher interest rates may be pushing up rental prices, as homeownership has become less affordable and more people are choosing to rent.

“The fact that rent is going up, that’s probably a reflection of interest rates, because landlords have to account for those costs as well,” Arlene Kish, director of Canadian economics at S&P Global Market Intelligence, said in an interview.

“To me the bigger concern is the fact that services inflation is rising at a steady rate. That probably is reflecting the increase in wages. We’ve seen wage inflation hitting 5.6 per cent year over year for the past two months,” she said.

The Bank of Canada has said that it is paying close attention to wage growth and labour-market tightness as increasingly important drivers of inflation. While wages have not kept pace with rising prices, labour costs are adding to inflation as companies compete for scarce workers and pass higher labour costs on to their customers.

“The tightness in the labour market is a symptom of the general imbalance between demand and supply that is fuelling inflation and hurting all Canadians,” Bank of Canada Governor Tiff Macklem said in a speech in November.

The bank expects inflation to slow in the coming quarters as the economy stalls, unemployment increases, and higher interest rates bite into consumer spending. It expects inflation to be around 3 per cent by the end of 2023 and return to the bank’s 2-per-cent target by the end of 2024.

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