Canada’s consumer price index hit the pivotal 2 per cent target in August as inflation continued a downward trajectory, according to Statistics Canada data released on Tuesday. The drop is thanks to lower gasoline prices compared to a year ago.
The Bank of Canada will need to continue rate cuts amid disinflation as well as rising unemployment and sluggish growth.
While the return to 2 per cent inflation raises the odds of a larger cut, the Bank of Canada is likely to continue with the slow and gradual approach of a 25 basis-point rate cut next month, with a possibility of another 25 basis-point cut in December.
Two 25 basis-point cuts will be favoured over a single 50 basis-point cut, because a larger cut could cause prospective buyers to rush into the housing market and for home prices to shoot up.
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Excluding gasoline, prices increased by 2.2 per cent in August, down from 2.5 per cent in July. All core measures of inflation also dropped, suggesting that disinflation is here to stay.
In the United States, the Federal Reserve is expected to announce its first rate cut in four years tomorrow, which will help keep the two central banks’ policy rates from diverging too much. Still, the anticipated decrease in the value of the Canadian dollar from rate divergence has not materialized.
The Fed’s decision will most likely not affect the Canadian dollar too much, but the rate cut cycle occurring in both countries could help spark investments among Canadian businesses.
The data
Mortgage interest costs rose at a slower pace year over year in August as the Bank of Canada dropped its policy rate.
But at 18.8 per cent, mortgage interest payments have been the largest contributor to price increases since December 2022—right before the Bank of Canada began raising rates. Excluding mortgage interest payments, the CPI rose by only 1.2 per cent, well below pre-pandemic numbers.
Gasoline prices fell by 5.1 per cent in August, making gasoline the largest contributor to the deceleration in prices.
Clothing and footwear prices dropped by 0.6 per cent on a monthly basis, the first decrease since 1971 as August is a heavy spending month on back-to-school shopping. The decrease highlights softening consumer demand as retailers cut prices to attract buyers.
The cost of groceries prices accelerated because of comparisons to a year ago, rising by 2.4 per cent, but still within expectations and not a point of concern.
The takeaway
The return to the 2 per cent CPI target has occurred much faster than anticipated. The Bank of Canada now needs to focus on rate cuts to enable business investments and consumer spending. With rate cuts, businesses will ramp up hiring, allowing for a recovery sooner than later.
