Today’s CPI data showed headline inflation hit the BoC’s Q1 projection, 5.1%, in just the first month of the quarter. Only one out of 15 professional forecasters polled by Bloomberg expected such a hot inflation print coming, with the consensus pointing to no change in the headline rate from December’s 4.8% reading.
While the headline rate sits above 5% for the first time since 1991 and the core rate is rising at its fastest pace since the introduction of the index in 1999, the headline data doesn’t tell the full story of Canada’s inflation backdrop. Services inflation ex. shelter, a broad proxy for domestic inflationary pressures, actually fell 0.2% in January and continues to show limited signs of demand-pull pressures. While it is worth noting that both Ontario and Quebec were subject to health restrictions during December and January, which likely restricted this measure’s rebound, the continued lacklustre performance of the index is an area of concern. Compounding these concerns is the narrow distribution of the inflation pressures; two-thirds of the 0.9% increase in MoM CPI (NSA) comes from food, transportation and shelter. The same three components contributed 83% to headline inflation between January 2021 and 2022.
Services inflation ex. shelter shows limited domestic demand price pressures
The lack of broadness and domestic inflationary pressures help explain why the market reaction to a multi-decade high in headline CPI and strong sequential momentum in the MoM data was relatively dull. The loonie marginally increased its gains on the day after the data release, while front-end Canadian bond yields rallied slightly despite bonds being bid across the G10 space today.
Despite the limitations to today’s CPI release, the increase in inflation can’t be fully explained away by the Bank of Canada.
While a 50bps hike in March remains the less probable scenario as per overnight index swap pricing, today’s data compounds the view that the Bank of Canada will have to hike rates by a minimum of 25bps. Any broadening in inflation drivers or pick-up in domestic demand-pull pressures will likely steepen the BoC’s rate trajectory relative to the Fed’s. Currently, overnight index swaps are pricing just shy of seven 25bps hikes by the BoC this year, similar to that implied for the Federal Reserve.
Inflation pressures remain narrower relative to H2 2021 average
Looking ahead, today’s CPI data is likely to remain supportive of the loonie within its current February range, but further upside is probably limited. Markets will remain focused on broader risk sentiment, and turn their attention this afternoon to the release of the January FOMC meeting minutes.
Simon Harvey, Head of FX Analysis
Jay Zhao-Murray, FX Market Analyst