Canadian CPI softer under the surface
If anything, the data indicates a further easing in price pressures below the surface. That might ordinarily be concerning for ratesetters with inflation already close to target, if not for the recent outbreak of war in the Middle East, and a subsequent spike in energy costs that has taken oil to $1
Canada’s February CPI report, the last major release ahead of the BoC’s rate decision later this week, offered little to suggest that the Governing Council should be worried by domestic inflation dynamics.
If anything, the data indicates a further easing in price pressures below the surface. That might ordinarily be concerning for ratesetters with inflation already close to target, if not for the recent outbreak of war in the Middle East, and a subsequent spike in energy costs that has taken oil to $100 per barrel. As such, we think that the Governing Council will signal caution on Wednesday, but that message is now likely to be more two-sided regarding the forward-looking balance of risks. If correct, that would also be more dovish than markets price as of writing, posing a headwind for the loonie.
Looking at the CPI data, headline inflation dropped from 2.3% YoY to 1.8% in February, as distortions from a federal sales tax suspension dropped out of the annual calculation.
Helpfully adjusting for this, core median and core trim CPI growth both dipped for the fifth consecutive month in February, with both measures left sitting at 2.3% YoY. Granted, that is above target for the BoC, albeit not by much. We suspect the Governing Council will be more concerned by the direction of travel, and this continues to point downward. Indeed, our own preferred measures of underlying price pressures are now clearly running below target.
Core CPI ex-shelter rose by 1.8% in the year to February, while CPI excluding rent and mortgage costs increased just 1.7% YoY.
We think this becomes more concerning for the Governing Council when married to recent jobs numbers. The economy shed 84k roles in February after 25k losses the month prior, while the unemployment rate jumped to 6.7%. This is clearly a soft labour market, even if headline figures are a little overstated due to idiosyncratic factors such as weather impacts and a drop in immigration.
But combined with today’s CPI data, we see a reasonable argument that domestic conditions might now be insufficient to support inflation at the BoC’s 2% target.
That means a nuanced message from the BoC is needed later this week. While external shocks will mean higher energy costs in the short term, this should be weighed against the downside risks to inflation stemming from domestic factors. If realised on Wednesday, this would be a more neutral message than expected by traders, with swaps predicting 1-2 rate hikes before year-end. A dovish steer from Governor Macklem and Co should keep USDCAD tracking higher then, assuming the Governing Council shares our concern around the state of domestic economic conditions.
Core-median and core-trim price growth continue to cool, offering a counterpoint risk-wise to the coming jump in energy CPI stemming from conflict in the Middle East