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Having hailed the disinflation progress in recent months back at April’s policy meeting, Governor Macklem highlighted that the Bank needs to see evidence that this can be sustained before policymakers could confidently begin to cut rates. Since then, almost all data points have supported an imminent commencement to the Bank’s easing cycle.
This includes the two intermeeting inflation reports, with both showing that disinflation progress in Canada has remained undisturbed for more than a quarter. In fact, April’s anomalous payrolls report provides the sole exception to this pattern, but even then we would recommend viewing that data in the context of an unemployment rate that returned to levels last seen in 2017.
As a result, given the evolution of the Canadian inflation data, and the broader context of the economy operating with excess supply, we think the Bank’s confidence threshold to cut rates has been reached and continue to look for a rate cut at the next meeting on June 5th.
Moreover, with the totality of the data suggesting that the Canadian economy remains cyclically weak, with that spilling over into firms’ hiring and pricing behaviours, we expect the Bank to cut rates again on September 4th, leaving them to cut rates twice before the Fed begins to move. While markets have converged on our view, with CAD swaps now pricing a rate cut next month at 60% as opposed to a coinflip, and implying a 73% chance of two rate cuts in the next three meetings, we still think there remains scope for Canadian rates to turn more dovish in the coming weeks.
With only Canadian GDP data due before the BoC next meets on June 5th, however, investors might have to wait until the next policy meeting to see USDCAD break back above the 1.37 handle and threaten to breach 1.38 once again.
Turning to today’s inflation report for April, the last before the BoC next meets on June 5th, the data extends the recent disinflation trend in the Canadian data as all annual inflation measures now sit comfortably within the Bank’s 1-3% tolerance band. Headline inflation grew 0.5% MoM on an unadjusted basis in April and 0.2% when seasonally adjusted, primarily as a result of higher gasoline prices (+7.9% MoM). Not only was this widely expected based upon real-time data, but negative base effects still brought the annual rate down by 0.2 percentage points on the month to 2.7% YoY, its lowest level since March 2021.
Given the magnitude of the increase in gasoline prices, the inflation outlook understandably improves further once removing the effects of energy components.
CPI ex food and energy increased just 0.3% on a non-seasonally adjusted basis, resulting in the annual rate falling 0.2pp to 2.7%. Moreover, the CPIX rate, which excludes the eight most volatile items and which was once the BoC’s preferred core measure, also fell considerably from 1.98% to 1.64% in April. Turning to the Bank’s more modern core inflation measures, they too fell by 0.3pp on an annual basis. CPI-trim fell from 3.2% to 2.9% having advanced just 0.145% on the month, while CPI-median similarly fell from 2.9% to 2.6% after rising just 0.142% on the month.
Moreover, there are grounds to believe this disinflation progress can be sustained too. The average underlying growth rate of both core measures remains considerably below the respective annual rates at just 1.64% on a 3-month annualised basis.
While this is a moderate acceleration from March’s reading of 1.35%, it marks the second month where the more timely sequential measure has printed below 2%, having previously been stuck in the range of 3-4% for much of 2023. Finally, our favoured measure, CPI ex rent and mortgage costs, which removes components directly linked to the stance of monetary policy and structural lags in inflation that other central banks discount, has continued to cool, dropping from 1.51% to just 1.34% YoY. This marks the seventh consecutive month this measure has printed below 2%.
Pick your fighter: annual rates of inflation in Canada are now all back within the BoC’s target range
While the narrative displayed by the aforementioned measures is compelling enough in itself, Bank staff will also find comfort in the details of today’s inflation report. Food prices fell by 0.2% MoM alongside recreation prices, while the March rebound in clothing inflation also proved short lived as prices didn’t change last month. Granted, shelter price growth still remains concerningly high at 0.5% MoM, but this sits outside of the Bank’s purview and instead should be addressed by fiscal policymakers through regulatory tweaks and tighter immigration policies.
On the whole, we think the sustained disinflationary progress in the Canadian data since April leaves the Bank little choice but to cut rates in two weeks’ time.
While slightly stronger growth at the start of the year and healthy April job gains suggest the BoC could throw caution to the wind and await two further inflation reports to cut rates in July without triggering any negative economic consequences, we think this poses a communications problem seeing as Bank staff have conditioned a rate cut on sustained disinflation progress that has now been delivered. Although short-term interest rate markets are becoming sympathetic with our base case, they continue to underprice the extent to which we think the BoC will cut rates this year. Should the Bank spark a dovish reassessment at their next meeting as we expect, the widening in US-Canadian rate differentials alone should reignite the prospect of USDCAD returning to 1.38.
Markets have turned more dovish on the BoC, but they haven’t converged to our base case enough for USDCAD to break back above 1.37 just yet
Author:
Simon Harvey, Head of FX Analysis