The Bottom Line:

• The tick lower in inflation in December to 1.8% was above our own assumption for a 1.5% increase, but largely due to a smaller than assumed reduction in prices from the temporary GST/HST holiday in December, and was still slightly below market expectations for a 1.9% reading.
• Controlling for the tax distortion, price growth was mixed but is still consistent with further signs of underlying easing in price growth.
• The CPI data will be impacted by the tax holiday into February, but a weakened Canadian GDP and elevated unemployment rate (with the potential for protectionist U.S. trade policy to make both worse) is pushing inflation expectations from businesses and households lower. That leaves the risks on price growth tilted to the downside and argue for further BoC interest rate cuts.

The Details:

• Headline CPI growth edged down to 1.8% in December from 1.9% in November, but with the slowdown entirely attributable to a drop in indirect taxes as the federal GST/HST holiday came into effect mid-month – restaurant prices fell year-over-year (-1.6%) for the first time in data going back to the 1960s.
• That tax impact was smaller than we assumed (we expected price growth overall to slow to 1.5% in December) and excluding indirect taxes, price growth picked up to 2.2% year-over-year from 1.7% in November.
• Details, though, were mixed and still broadly consistent with underlying Canadian inflation pressures continuing to ease.
• Much of the ex-taxes increase in price growth in December came from a surge in travel services prices (up 7.9% year-over-year) that are highly volatile around the holiday season.
• Growth in mortgage interest costs continued to slow as earlier declines in interest rates continue to filter through household effective borrowing costs, but still account for a disproportionate share of total year-over-year CPI growth (~30% as of December).
• Month-over-month growth in the BoC’s preferred median and trim core measures (which exclude the impact of indirect taxes) edged up to 3 1/2% at an annualized rate over the last three months, although year-over-year increases ticked down to to 2.4% and 2.5%, respectively, from 2.6% (both) in November (and by our count the year-over-year measures would have been both right around 2% if mortgage interest costs were not included in their calculations.)
• The breadth of price growth (excluding tax change impacts) over the last three months widened slightly – the share of CPI components with ex-tax price increases above a 3% annual rate over the last three months rose to 51% in December from 45% in November, but is still well below the 2022 average of 67%.

Source: RBC Economics