‘Unsettling news’: What inflation’s uptick means for the Bank of Canada

An acceleration in the annual rate of inflation to end 2023 won’t be enough to panic the Bank of Canada heading into its first interest rate decision of the year, economists argue, but it won’t hasten the timeline for cuts, either.

Statistics Canada said Tuesday that the annual inflation rate ticked up to 3.4 per cent in December, thanks to gas prices and still sticky price hikes at the grocery store.

That’s up from the November inflation rate of 3.1 per cent.

Economists had widely expected a temporary inflation spike, owed largely to a smaller drop in gasoline prices in December compared with a year ago. Gas prices have declined for the fourth consecutive month, StatCan says.

Prices at the grocery store rose 4.7 per cent annually last month, StatCan says, the same pace seen in November.

Shelter inflation such as climbing rent and mortgage costs continued to drive the cost of living higher in December.

Canadians paid 31.1 per cent more for air transportation in December than in November as the holiday season pushed up demand for airfare, StatCan says. Cheaper prices on travel tours month-to-month helped moderate this pressure.

Higher costs for fuel oil and passenger vehicles were also contributing to inflation last month, the agency says.

With December marking the last month of the year, Statistics Canada says the annual average inflation rate for 2023 was 3.9 per cent, down from a 40-year high of 6.8 per cent in 2022.

The latest inflation print comes a day after the Bank of Canada released its quarterly business outlook survey, which showed fewer firms are planning steep and frequent price hikes in the year to come.

RBC economist Claire Fan says that while business pricing behaviours haven’t fully normalized yet, the Bank of Canada’s surveys suggest inflation should be less intense in 2024.

Tuesday’s report comes about a week ahead of the Bank of Canada’s next interest rate decision set for Jan. 24. The central bank has held its policy rate steady at 5.0 per cent in the past three decisions, and has warned that rates might need to rise higher to fully bring inflation back to its two per cent target even as many forecasters start to pencil in rate cuts later this year.

While the uptick in headline inflation might have been expected, there were signs of acceleration in the central bank’s closely watched metrics of core inflation, too.

BMO chief economist Doug Porter said in a note to clients Tuesday that core inflation holding around mid-three per cent range will be “unsettling news” for the Bank of Canada, proving that the so-called “last mile” of the inflation fight will be the hardest.

With wage growth still elevated and signs that the housing market might be waking up from its hibernation, Porter argued that the central bank will have to hold a “cautious stance” in next week’s decision. He reiterated BMO’s call for interest rate cuts to begin in June.

TD Bank economist Leslie Preston also said the December inflation report will pour water on calls for an easing in the Bank of Canada’s policy rate.

“If you are looking for data to signal a rate cut is imminent, this isn’t it,” she wrote in a note.

TD Bank nonetheless has a more aggressive timeline for easing to begin, expecting the first cut in April. Preston said she expects inflation and the wider economy will have slowed enough to give the Bank of Canada confidence that inflation is heading back to two per cent to start easing monetary policy by then.

Fan says she expects the inflation release on its own won’t be “too concerning” for the central bank heading into next week’s rate decision.

Signs of deterioration elsewhere in the economy and a softening in the labour market give RBC the confidence that the sticky core inflation metrics will eventually begin to ease; the question remaining is how long that will take, she says.

“That, in a way, just really warrants this slow approach. The Bank is in no rush to cut rates,” she says.

Fan expects the Bank of Canada will hold its policy rate steady on Jan. 24 and keep the same posture it had at the end of 2023, keeping hints for rate cuts off the table until it’s seen more inflation prints in 2024 and another round of business surveys.

RBC expects the Bank of Canada will pivot to rate cuts around mid-year. Fan notes that risks of an inflationary stall pushing back the timeline for rate cuts and risks of a steeper economic downturn moving forward the schedule for easing are “pretty evenly distributed” at this juncture.

Possible stalls in the Bank of Canada’s inflation fight come as the economy continues to show signs of slowing.

Andrew DiCapua, senior economist at the Canadian Chamber of Commerce, tells Global News that the central bank will have a tough job trying to avoid tilting the economy into a recession while ensuring it tamps inflation all the way back down to two per cent – the coveted “soft landing” scenario.

He also says that the Bank of Canada, while it operates independently, will feel pressure to keep its policy rate moves close to those of the United States Federal Reserve. The exchange rate of the Canadian and U.S. dollars are closely tied to the country’s central bank rates, and too much of a divergence here could fuel inflation on trade between the nations, he notes.

While inflation in the U.S. has also clocked in at 3.4 per cent in its latest reading, DiCapua says the Fed likely has a bit more bandwidth to work with in its own inflation fight because the economy south of the border is still running strong. That gives the Fed more “leeway” to run its interest rates higher for longer to tame inflation without tanking the economy, he says.

“I think the United States is definitely more in the soft landing camp, whereas Canada is really growing at about zero per cent, and we could dip into recession in the second half of this year,” DiCapua says.

Officials at the U.S. Fed have recently signalled that there could be as many as three interest rate cuts from that central bank in 2024. Wall Street investors and many economists expect the first cut in March.

However, the Bank of Canada diverged from the tone taken by the Fed last month.

“The Fed is going to do what they need to do. We’re going to focus on what needs to be done here in Canada,” Governor Tiff Macklem told a business audience in Toronto after a speech in December.

“We have not started having that discussion (about cutting rates), because it’s too early to have that discussion. We’re still discussing whether we raised interest rates enough and how long they need to stay where they are.”

A top Federal Reserve official said Tuesday that he is increasingly confident that inflation will continue falling this year back to the Fed’s two per cent target level.

The official, Christopher Waller, an influential member of the Fed’s Board of Governors, noted that inflation is slowing even as growth and hiring remain solid — a combination that he called “almost as good as it gets.”

“The progress I have noted on inflation, combined with the data in hand on economic and financial conditions and my outlook has made me more confident than I have been since 2021 that inflation is on a path to per cent,” Waller said in written remarks to the Brookings Institution.

Waller meanwhile cautioned that the Fed might not cut rates as urgently as many on Wall Street have envisioned. He noted that the economy is continuing to expand, with the unemployment rate at just 3.7%, not far above a half-century low, while inflation cools.

“But will it last?” he asked.

Fed officials, he added, will want to see further evidence that inflation is still on track to two per cent before embarking on rate cuts.

“We can take our time to make sure we do this right,” he said.

Source link