Today’s CPI release saw headline inflation overshoot expectations by 0.1 percentage points to post a print of 2.4% in January – the highest reading in 15 months. However, the loonie’s reaction was relatively muted.
Expectations of a Bank of Canada rate cut were trimmed at the margin in the short-run but the currency failed to take positive surprise as a source of stimulus.
The reason? The underlying data is less positive than the headline reading.
Higher gasoline prices, around 11.2% YoY, juiced the headline reading but the average core measure actually fell by 0.04pp to 2.03% YoY. This is best highlighted by the CPI common reading which fell to 1.8% YoY in January from 2.0%.
While the slump itself isn’t anything overly concerning due to the common measure sitting at 1.8% or higher since January 2018, it highlights that once the idiosyncratic oil price effect is stripped out that underlying inflation may actually be weaker than expected.
This is likely to weigh on BoC policymakers minds, especially when looking forward towards Q2, as economic activity is yet to show a substantial rebound from Q4’s stagnation and real wage growth continues to be siphoned into deleveraging as savings intentions rise.
The concerns only increase when you project the likely oil effects towards February’s reading.
Oil markets are some 17% off from January’s high while the average price of a barrel of WTI jumped by around $5 in February 2019. The two effects are likely to cause oil prices to flip from a source of stimulus to a headwind for inflation data going forward.
Despite the aforementioned downside risks to the BoC outlook, we still believe the expectations of a rate cut by the central bank in H1 are stretched.
Markets are currently pricing a 50% probability of a 25bps rate cut in the June meeting. Without clarity on the economic impact, the coronavirus had on China’s economy, and thus the true spill over to global growth conditions, we maintain our stance that the Governing Council will remain on hold during Poloz’s term.
Chart 1: CPI excluding gasoline falls to 1.9% YoY
Chart 2: Gas and fuel prices drive headline inflation in January
Chart 3: Rate cut bets are trimmed after CPI release but USDCAD is less sensitive
This view is highly likely to change once China’s economic data is released and the fiscal response is announced, but for now, we believe the housing market sets a higher bar for a rate cut than markets currently imply for the coming meetings.
Author: Simon Harvey, FX Market Analyst at Monex Canada.