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The Bank of Canada remains on track to cut rates in June despite the latest data showing headline inflation ticked up from 2.8% in February to 2.9% YoY in March, in line with expectations.
This is because most of the uplift in inflation last month was driven by gasoline, which increased 4.9% MoM and 4.5% YoY. Overall, rising gasoline prices contributed 19bps to headline inflation, which itself rose 0.6% on the month. Removing the effect of gasoline, the traditional core measure of inflation continued to fall, dropping 0.1pp on the month to 2.8% YoY. Moreover, the remainder of inflation stemmed from shelter, which rose 6.5% YoY and 0.4% MoM, contributing 11bps to headline inflation month-on-month. Specifically within shelter, most of the inflation impulse came from mortgage interest rate costs, which counterproductively continues to boost inflation due to the BoC’s restrictive stance, a factor that should be discounted by monetary policy members. By removing just mortgage and rent costs, headline inflation rose just 1.51% YoY. This is some distance below the BoC’s target.
The most compelling case for policy easing was once again presented by the BoC’s more modern core inflation measures, CPI-trim and CPI-median.
Both measures fell on a year-on-year basis, with CPI-trim dropping 0.1pp to 3.1% and CPI-median dropping 0.2pp to 2.8%. However, a look at nearer-term price pressures should tell policymakers everything they need to know. The average monthly increase across both measures was just 0.12%. With February’s outturn also weak at 0.12% and January’s increase even weaker at 0.07%, the 3-month annualised rate of core inflation fell even further in March and now holds a 1-handle (1.25%). This marks a significant slowdown in underlying price pressures from the 3.5-4.5% range this metric oscillated within back in 2023. Finally, the Bank has recently pointed towards the breadth of inflation as reason to keep policy on hold. The latest data have also been constructive on this front, with the proportion of the CPI basket rising above 3% YoY dropping 11pp to just 44% in March when using level 4 component data.
The BoC should cut based on the progression of the 3-month annualised rate of core inflation alone, which has fallen to levels last seen in May 2020
With the Bank stressing that it was “looking for evidence that this downward momentum [in inflation] is sustained” before cutting rates earlier this month, today’s data suggests that June’s meeting is practically a formality at this point. The question for markets is now how fast the BoC will have to cut thereafter. Based on the sluggish momentum in underlying inflation and the fact that mortgage interest rates inflation should soon cool along with underlying mortgage rates, we suspect the BoC will have to bring the policy rate down rapidly to reflect the weaker underlying strength of the economy. In our view, should the BoC cut fewer than four times this year, there is a material risk that headline inflation may undershoot the Bank’s 2% target in 2H24. Markets are slowly converging on this view, although there remains some hesitation to fully buy into it given the more inflationary backdrop in the US and the Bank’s historic reluctance in deviating too far from the Fed with its monetary policy setting. This largely explains why pricing of the BoC’s easing cycle has only gradually increased following today’s data, with just a 66% probability now factored in for June and 2.5 rate cuts in total for this year.
We doubt markets can hold this view for much longer, however, and anticipate a further widening in rate differentials in Q2 as weaker Canadian data continues to contrast with signs of greater economic resilience in the US. This should see USDCAD trade higher into the 1.38-1.40 range that we anticipated for Q2, with the currency pair having already traded slightly into this range following today’s release.
USDCAD breaks into our forecasted range for Q2 as front-end rate differentials widen in favour of the US dollar
Author:
Simon Harvey, Head of FX Analysis