Commonwealth_ Canada’s consumer price index (CPI) rose by 1.8 per cent in December compared to the same month a year earlier, slightly below the 1.9 per cent increase anticipated by economists. This marks a key data point for the Bank of Canada ahead of its interest rate decision scheduled for January 29. Statistics Canada highlighted that the federal government’s GST/HST tax holiday on select goods, such as restaurant food and alcoholic beverages, played a significant role in slowing inflation growth for the month. When food is excluded, the CPI rose by 2.1 per cent in December.
Inflation Outlook: Mixed Signals
The implications of December’s inflation data have divided economists. While the tax holiday provided temporary relief, underlying factors point to potential volatility in the months ahead. Michael Davenport, an economist at Oxford Economics Canada, anticipates a rebound in inflation above two per cent by March, as the effects of the GST/HST tax holiday fade. Additionally, we expect the scheduled increase in the federal carbon tax levy in April to further boost inflation.
Davenport also notes potential risks from external factors, such as tariffs from the United States and the possibility of the carbon tax being eliminated if there is a change in government. These variables could contribute to further inflation volatility throughout the year. Even with these problems, Davenport says that the pressures behind inflation are still pretty low, which suggests that inflation is still under control.
Bank of Canada’s Approach
The Bank of Canada has historically focused on broader inflation trends and the level of economic slack rather than temporary fluctuations. Temporary measures, such as the GST/HST tax holiday, are typically set aside in the Bank’s analysis. However, recent developments in inflation are likely to keep policymakers cautious. The central bank has already implemented significant interest rate cuts, totaling 175 basis points, since rates peaked at 5 per cent during this cycle. Its current neutral range for interest rates where rates neither stimulate nor constrain economic growth is between 2.25 per cent and 3.25 per cent.
Insights from David Rosenberg
David Rosenberg, economist and founder of Rosenberg & Associates Inc., believes that the Bank of Canada’s task in managing inflation is far from complete. Despite the cumulative rate cuts, inflationary pressures remain in specific areas, particularly shelter costs. Mortgage costs have been a significant contributor to inflation since the Bank began its rate-hiking cycle in early 2022.
However, Rosenberg argues that mortgage costs should be excluded when analyzing inflation, as they represent a drain on consumer spending power rather than a true indicator of demand-driven inflation. Based on his preferred measure, which strips out mortgage interest costs, inflation in December was just 1.3 per cent year-over-year.
Rosenberg also points out that inflation in other categories representing 70 per cent of the CPI basket has been tracking below one per cent since August 2024. This indicates that while certain components, such as shelter costs, remain elevated, the broader inflation picture is more subdued.
Broader Implications
The December CPI data underscores the complexity of the inflation landscape in Canada. While temporary measures such as tax holidays and future carbon tax adjustments add short-term volatility, underlying inflationary pressures appear manageable. For the Bank of Canada, this mix of factors necessitates a cautious yet flexible approach as it considers its next interest rate decision.
Mortgage interest costs, which have surged following rate hikes, continue to weigh on consumer spending power. However, excluding these costs makes the inflationary environment appear less concerning. This duality suggests that while the Bank of Canada has made significant progress in reining in inflation, it may still have further to go in achieving price stability., Looking ahead, the interplay of domestic policies, such as the carbon tax, and external factors, like potential U.S. tariffs, will likely shape Canada’s inflation trajectory. Economists expect volatility to persist, with inflation temporarily rising above two per cent in the coming months before stabilizing. The Bank of Canada’s decisions will remain pivotal in navigating these challenges, balancing economic growth with inflation control.
