December 21, 2023
Canada’s annual inflation rate came in hotter than expected in November, at 3.1% versus expectations for 2.9%, prompting money markets to modestly ease back their bets on interest rate cuts early next year.
Month-over-month, the consumer price index was up 0.1%, compared with a forecast of a 0.1% decline.
Still, headline inflation remains broadly in line with the Bank of Canada’s projection for it to hover around 3.5% until mid-2024, before slowly cooling to the bank’s 2% target by end-2025. CPI-median and CPI-trim – two of the BoC’s three core measures of underlying inflation – also held steady at 3.4% and 3.5%, respectively.
Taken as a whole, the inflation report was modestly hotter than consensus expectations and we’re seeing a predictable market response as a result. The Canadian dollar immediately shot up about two-tenths of a U.S. cent, to 74.88 cents. The two-year Canadian government bond yield, which is quite sensitive to central bank policy moves, took a noticeable turn higher upon the 830 am Statistics Canada report, shooting up about 5 basis points to 4.055%. The Canada five-year bond yield – heavily influential on fixed mortgage rates – rose a couple basis points.
Implied probabilities in the swaps market immediately priced in a lower chance of an interest rate cut by the Bank of Canada in March, at about 38%. Prior to the data, it was at 46%. But markets are still heavily betting on a cut next spring, with an 82% probability in April – down modestly from 88% prior to the data.
Interest rate swaps are changing all the time, and we may see further adjustment of these numbers later this week when a number of U.S. economic reports are released. But for now, the main message money markets are signalling is that monetary easing is coming in the first half of next year, and by year end, traders are betting on about a full percentage point of cuts to the bank’s overnight rate.
And despite the Bank of Canada’s insistence that a further hike in interest rates shouldn’t be ruled out, money markets are assigning virtually zero chance to that scenario.
The following table details how money markets are pricing in further moves in the Bank of Canada overnight rate, according to Refinitiv Eikon data as of 9 am. The current Bank of Canada overnight rate is 5%. While the bank moves in quarter point increments, credit market implied rates fluctuate more fluidly and are constantly changing. Columns to the right are percentage probabilities of future rate moves.
Here’s how economists and market strategists are reacting to the data:
Canadian inflation was surprisingly sticky in November, with every metric above expectations. Headline inflation held at 3.1% y/y, while the two core measures were steady at 3.5% (Trim) and 3.4% (Median). The lack of progress prompted a bit of a re-think for markets after they rushed to price in aggressive rate cuts in 2024. There’s no debate that the November inflation figures were disappointing, but the overriding trend remains intact: inflation is slowing. Core prices are rising 2 ppts less than the peak pace, while headline inflation is a massive 5 ppts off the high. The slowing trend was never going to be a straight line (unlike the acceleration), so it’s important to look at the bigger picture. Despite the inflation miss, we continue to anticipate rate cuts will start around mid-2024. Tuesday’s figures highlight that we could see some bumps in the road, and there’s a risk that inflation is a bit more stubborn than expected.
Benjamin Reitzes, Canadian Rates & Macro Strategist, BMO Capital Markets
Headline inflation proved stickier than anticipated in November…. There was surprising strength in recreation, education and clothing prices. That said, shelter was still the largest single contributor to total inflation. Excluding shelter, inflation was just 1.9% in November.
Other measures of underlying inflation also showed signs of cooling down. While the annual rates of the Bank of Canada’s core median and trim indicators remained around 3.5%, the average of the three-month annualized rates slowed to 2.45% from 2.86% in October. Today’s report represents less progress in taming inflation than we had expected. That said, there are still a number of signs pointing to a further normalization in underlying price pressures.
Bond yields are rising as some of the most aggressive bets on rate cuts are getting pared back. However, we are retaining our forecast that the Bank of Canada has enough evidence in hand to begin trimming rates in April 2024.
Royce Mendes, managing director & head of Macro Strategy at Desjardins Capital Markets
A temporary step backward. The renewed acceleration in core inflation pressures in November was partly due to a jump in travel tour prices, which is likely to be reversed in December. Nonetheless, by highlighting the continued uncertainty of how long it will take for core inflation to return to 2%, the move still reduces the chance that the Bank will cut interest rates as soon as we forecast in March. …
The good news is that the upside surprise appears to have been largely due to an unexpected surge in travel tours prices. Typically, they fall by about 10% m/m in non-adjusted terms in November, but this November they rose by almost 5%. According to Stats Can, that was “mainly attributable to events held in destination cities in the United States”. That move alone seems to have pushed up the CPI by 0.2% m/m, but it should be reversed before long. …
It seems we cannot blame travel tours for stronger core inflation pressures entirely, however, because the CPI-trim and CPI-median indices – which exclude large price changes in either direction – both rose by a larger 0.3% m/m, the strongest average gain in three months. That kept the annual core inflation rates unchanged at an average of 3.5%. The upshot is that our forecast for the first interest rate cut in March is looking less likely although, given there are still another two CPI reports before that meeting, we are not minded to change our forecast for now.
Stephen Brown, deputy chief North America economist, Capital Economics
Sorry but I just can’t hop on the bandwagon. In my professional opinion, November’s core inflation readings leaned more toward continued hike risk than toward market pricing for a cut by March/April that would be a major policy error right into the thick of the Spring housing market and Winter government budget season. For now, however, this is short-term data noise for a central bank that is saying it wants a lot of data before doing much of anything.
Key are the core measures that all lit up again …. These are all far too warm for the BoC’s liking. The readings are volatile. While one or two months of a soft patch don’t determine a trend, neither does a month of renewed acceleration in November.
Nevertheless, at the margin, the latest inflation data suggests that the prior couple of months might have simply been yet another false dawn for sustainably getting inflation toward the 2% target.
And why would you expect anything but persistent upside risk to inflation Canada?
- Wages are absurdly hot in relation to inflation and tumbling labour productivity with one-third of the workforce that is unionized cementing strong wage gains for years to come.
- 430k jobs have been created so far this year despite all of the gloom.
- Will there be mass job shedding going forward? One out of two of the jobs created since the start of the pandemic are not going away because they’re all in the public sector absent austerity measures. Labour hording is a common theme in the private sector.
- Immigration is excessive full stop. Canada just added about 431k people in Q3 alone. That’s like presto, here’s a new city of London, Ontario created in one quarter. Or almost a new City of Hamilton. A 1.1% q/q nonannualized increase in population in one quarter. Statcan noted that even just the first 9 months of this year exceeded population growth for any other year since Confederation in 1867. In percentage terms, q/q population growth of 1.1% was the fastest since 1957. Population growth is now at 3.2% y/y and the fastest of any peer group major industrialized nation by far. Population has increased by 1.25 million people in just one year and population is 2.29 million higher than two years ago in a country that started with just 38.2 million folks at the time and now has 40.5.
- The problem remains that there is little to no housing available for them and it’s only going to get worse. Ditto for N.A. auto inventories and with the retail inventories to sales ratio having come off the depressed bottom during the pandemic to a still lean pre-pandemic level. Ditto for inadequate infrastructure in transportation, in health care services, etc. That connotes capacity pressures upon infrastructure and concomitant funding and price pressures over time.
- Surveys of inflation expectations remain above the BoC’s inflation target for years to come pending January’s updated surveys.
- CAD is undervalued.
- Fiscal stimulus is ongoing and ages past any such requirements with the threat of more to come as governments re-issue forecasts that tamp down interest expense projections. Why? Because financial market conditions are prematurely easing in my view with the 5-year GoC yield at 3.25% down 115bps since Fall and pricing a full cycle’s worth of rate cuts down to little term premium over neutral rate assumptions. With an election looming by October 2025 and the current government down in the polls, it’s probably rather unlikely they’ll tuck aside any reduced projections for interest expense instead of spending it on other things.
Yeah. Throw rate cuts on top of that at a central bank that can’t forecast inflation to save itself despite its bold commitment to its forecasts. You’ll never cut again afterward or you’ll have to chase inflation higher all over again and lose further credibility as a central bank if cuts are delivered too early and too powerfully. The key message here is to cast aside past cycles and understand the idiosyncratic risks to Canada.
Derek Holt, vice-president & head of Capital Markets Economics, Scotiabank
Base effects suggest that inflation is almost certain to take at least a one-month detour higher in next month’s release (prices fell very heavily last December). The overriding point is that despite the recent mirth over potential rate cuts in 2024, we clearly can’t assume that the inflation fight is finished — as Governor Macklem has so oftened warned one and all.
Grocery prices continue to moderate, as widely anticipated—though they are still sticky at 4.7% y/y (down from 5.4%). Notably, the overall result was slightly flattered by the removal of the carbon tax on fuel oil; the latter costs saw a 23.6% y/y drop. Shelter costs are a whole different ballgame, and remain the sore spot. Mortgage interest costs did ease slightly on a yearly basis, but remain the number one contributor to headline inflation at up 29.8% y/y. Rent is relentless, and next in line at up 7.4% from year-ago levels. …
Not intending to completely douse the holiday spirit, the bigger picture is that Canadian inflation was still sitting at a towering 6.8% a year ago, or almost 4 percentage points higher than today. Such swift and heavy declines in headline inflation are rare, and have typically only been witnessed in the wake of a recession; so the fast fall in the past year is very much welcome news. It also keeps Canadian inflation precisely in line with the U.S. pace.
Bottom Line: Today’s moderately disappointing result drives home the point that we still have n inflation fight on our hands—in case there was really any doubt. Still, the bigger picture remains intact: The underlying inflation trend is lower, the economy is chilly, and the Bank is expected to begin trimming rates around mid-year. As an aside, this result will not be a big shock to the Bank, as it had pencilled in an average inflation rate of 3.3% for Q4 in its latest forecasts (which now looks doable, with December likely to print higher). Still, the latest result reinforces the message that markets had been a bit aggressive in their pricing of early and often rate cuts.
Douglas Porter, chief economist, Bank of Montreal
Today’s CPI report was an upside surprise that followed slower prints in prior months, and should not have changed the story that inflation has been broadly easing in Canada, alongside weakening macro backdrop. Broader ‘core’ measures of price growth still improved in November and some of the largest contributors to near-term price pressures, namely mortgage interest costs and rents, actually eased by more than expected. If anything, the release today serves as a reminder that inflation readings can still be “sticky”, and why we continue to expect a cautious approach as the BoC starts to think about when to begin cutting interest rates. Our expectation is for the first rate cut to come around mid-year 2024, contingent on further (but widely expected) softening in CPI readings in the months ahead.
Claire Fan, economist, Royal Bank of Canada
Headline inflation failed to ease as expected in November, but softer readings on its core measures compared to earlier in the year should still give the Bank of Canada some comfort that underlying trends are headed in the right direction. … If there is any good news in today’s report it is the fact that, with drivers of inflation becoming more narrowly based than they were earlier in the year, the Bank of Canada’s preferred core measures of CPI-trim and CPI-median continued to show softer trends than earlier in the year at 3.5% and 3.4%y/y respectively. On a 3-month annualized basis the core measures were softer, at 2.3% and 2.6% respectively. …
With base effects from gasoline prices turning less favourable next month, headline inflation will likely accelerate briefly, before easing more sustainably over the spring and summer next year. However, with drivers of inflation becoming less broad-based, the Bank of Canada’s preferred core measures should continue to decelerate, which combined with a sluggish trend in economic activity will likely bring a first interest rate cut in June next year.
Andrew Grantham, senior economist, CIBC Capital Markets
The Bank of Canada got a real mix in their inflation stocking this month. There were a few lumps of coal in the form of no progress on headline inflation, and continued strength in services inflation. But, when they dig down to the bottom of the toe there is a shiny bauble – that their preferred core inflation measures averaged just below 2 ½% on a annualized basis over the past three months, the slowest pace since the beginning of 2021.
Governor Macklem may be humming All I want for Christmas is two (percent), but he is going to need to wait a little longer for that gift. Canada’s economy has cooled in recent months, and inflation is slowly feeling the chill. We expect weaker demand in the economy will gradually see inflation come down enough for the Bank of Canada to cut rates in the second quarter of next year.
Leslie Preston, managing director and senior economist, TD Economics
A main takeaway from today is that although the 3-month moving average of the Bank of Canada’s preferred measures of core inflation continued to fall, the year over year average of these measures are still not within the bank’s desired range of 1% to 3%. Moving in the right direction but not there yet.
The Bank of Canada has acknowledged the next move in rates is likely lower but have said they need to see “not one or two months” but “a number of months” of deceleration in inflation before cutting interest rates. This suggests that rate cuts are still a little way off and markets may have gotten a little ahead of themselves.
Today’s print shows the risks are still somewhat two sided with inflation still a concern and somewhat sticky, but also slowing the economy too much and causing undue hardship is also undesirable. It’s a delicate landing to stick, but we think continued economic deceleration will bring inflation closer to target as 2024 progresses.
Michael Greenberg, senior vice president, portfolio manager, Franklin Templeton Investment Solutions
We understand that monthly volatility can occur, and that progress on inflation will not necessarily be linear. For this reason, we believe it is preferable to look at the trend over the last three months to assess the current situation. In doing so, we note that the CPI-Trim and CPI-Median are posting annualized rates of 2.6% and 2.3% respectively, their lowest pace since February 2021. This is comforting to see those measures comfortably back in the target range of the central (1 to 3%). All in all, we don’t put too much emphasis on this slight reacceleration in inflationary pressures in November. We have repeatedly pointed out that inflation is a lagging indicator of economic conditions and that it would be dangerous to base future monetary policy solely on current price pressures, given the lag in its transmission to the economy. The latter is showing signs of weakening, with GDP contracting in Q3 and the unemployment rate rising substantially since last April.
Matthieu Arseneau and Alexandra Ducharme, economists with National Bank Financial
