News & Analysis

Headline inflation in Canada fell by two tenths of a percent to 3.8% YoY, as the monthly impulse turned negative at -0.1% MoM. The downward pressure on headline inflation largely came from a decline in gasoline prices, but even when focusing on the Bank of Canada’s preferred measures of core, price pressures softened in September.

On a year-on-year basis, core-median fell by -0.2pp to 3.7%, while core-trim fell by -0.3pp to 3.8%. More importantly, the momentum in those core measures declined, with the annualised 3-month averages of median and trim falling by -0.8pp and -0.4pp, respectively. The breadth of inflation narrowed dramatically as well, with roughly 1 in 5 components of the CPI basket seeing monthly increases in excess of 3% annualised, compared to nearly half in the previous month. In terms of major contributors to overall inflation, only shelter costs remained a concern, delivering a +0.14pp contribution to the negative print. Even after accounting for seasonality, the impulse to all items was consistent with the 2% annual target, tracking at 0.2% MoM. All in all, today’s report is perhaps the best news that the Bank of Canada has received in months, clarifying what was a somewhat mixed run of data since the previous meeting. Despite some indications in yesterday’s surveys suggesting that inflation could prove sticky—firms’ and consumers’ inflation expectations are tracking between 3-4% over the next two years, and wage expectations are high as well—the Bank of Canada will likely take confidence in today’s report and hold rates steady at 5% at next week’s meeting.

We further expect officials to place a renewed emphasis on the closing output gap to suggest that, in the context of subdued domestic demand conditions, inflation is set to normalise further as we head into next year.

The FX market reaction to today’s release was captivating, with USDCAD rallying about 75 pips in a knee-jerk move, erasing two days of the loonie’s gains, before consolidating most of the move. It cannot be fully attributed to Canada CPI, however, considering that US retail sales beat expectations at the same time, driving a broad USD bid. Against the backdrop of rising core yields, the dovish response to today’s inflation response in Canadian government bonds stands out, with only front-end yields in New Zealand trading lower on the day on a similarly constructive inflation release.

August’s uptick in core inflation turns out to be a false alarm

This is the kind of inflation report that can genuinely make a central banker feel elated. Food (-0.1%), energy (-1.0%), core (-0.1%), and goods (-0.3%) prices all fell outright on the month while services prices held flat.

Within the major components, only shelter (+0.5%) and clothing (+0.9%) posted increases that were out of line with historical norms, and clothing is both a small component (4.3% of the basket) and saw subdued price pressures over the past year. Within the shelter basket, mortgage interest (+2.6%) and rents (+0.8%) drove the increase, with the cost of repairs, taxes, and utilities all holding flat or declining outright. Part of this is the Bank of Canada’s fault—after all, higher overnight rates get passed onto banks, which get passed onto mortgage-holders, and rents see upward pressure from the substitution effect as fewer people opt to buy homes. Governments also can take a share of the blame, having implemented policies that restrain supply and boost the demand for housing. But even so, the Bank of Canada likely won’t take too much issue with higher housing costs in the context of broader disinflation, particularly since the present goal of monetary policy is to crowd out excessive discretionary spending.

The latest report suggests this is taking effect. Components like recreation (-1.2%) and restaurants (+0.2%) are both trending down, which fits with the latest evidence in the CSCE that nearly 6 in 10 Canadians have cut back on discretionary spending to protect themselves against inflation.

The CPI data also mesh with the latest survey evidence in the sense that consumers display less willingness to spend on goods as opposed to services. Considering that the majority of firms and consumers say that they have not yet seen the full impact of monetary policy on their finances, we anticipate the downward trend in core prices to persist, particularly for goods. Headline inflation is a different matter, however. Gasoline prices have continued to track lower in October on falling global demand and a supply glut associated with high refining margins for diesel fuel. But natural gas futures have spiked up, with Henry Hub tracking nearly 17% higher than a month ago. We therefore expect energy to pose a smaller drag on headline inflation next month, but overall, we think inflation will continue to normalise.




Jay Zhao-Murray, FX Market Analyst


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