News & Analysis

Headline inflation in Canada beat expectations by two tenths of a percent in September, printing at 6.9% year-on-year.

While this supports the view that the BoC will need to keep tightening policy at next week’s meeting, the slow pace of the headline gains in sequential terms (+0.1% MoM) and the continued moderation in the headline measure from 7% in August due to base effects suggests the BoC won’t be inclined to match the Fed with another 75bp hike at next week’s meeting. Additionally, while core inflation pressures remain somewhat elevated at 0.3% MoM when excluding food and energy, the BoC doesn’t find itself in the same situation as the Fed, which has seen US core inflation consistently exceed 0.5% in the last few months. Out of the Bank of Canada’s preferred core measures, the median rate held stable at a downwardly revised level of 4.7%, while the trimmed measure continued to print at 5.2%. The only core measure to increase is the core-common index, but Bank of Canada Governor Tiff Macklem has already disregarded its usefulness in real-time earlier this month due to the large historical revisions it is subject to in this “generalised” inflation environment.

Overall, while still a robust inflation report, we don’t think the latest inflation data will tip the balance for the BoC next week, especially in the context of falling inflation expectations as per Monday’s business survey data. We continue to expect a 50bp hike to 3.75% on Wednesday, in line with consensus but below market expectations.

Within the CPI basket, monthly inflation pressures were fairly broad-based, but price increases in most categories were almost completely eroded by the 1.9% collapse in transportation costs, which was largely due to the 7.4% drop in gasoline prices. Transportation contributed -0.32 percentage points to overall month-on-month inflation in September, negating the effect of both higher shelter costs and food—the two biggest inflationary components of the month. While the BoC could point to the recent spike higher in global oil benchmarks to argue that the sources of the recent disinflation are susceptible to reversion, we don’t see this argument as compelling enough to warrant the financial stability risks that would accompany another 75bp hike.

The main contributor to September’s stronger inflation report was shelter at +0.15pp.

While a 0.5% monthly increase in shelter costs is nothing to completely disregard, especially given its contribution within the CPI basket as a whole, it is worth noting that one of the main drivers of its price growth was higher mortgage interest rate costs, which is counterproductive for the BoC’s readthrough given that it is a negative by-product of their own inflation tackling measures. Outside of that, higher maintenance costs, home and mortgage insurance and energy costs also played an outsized role. What will be more important for the BoC are the low levels of rent inflation and homeowners’ replacement costs; signs that its hiking cycle is starting to filter through to lower housing demand. This is the fifth month where these components have experienced disinflation in YoY terms.

Despite the positive beat in the headline figures, the loonie couldn’t hold onto early gains as it immediately strengthened by a tenth of a percent against the greenback before unwinding.

The reaction in rates was stronger, with Canadian 2Y and 10Y yields both increasing 8bps on the day before settling at a higher equilibrium, however, the support this provided to the Canadian dollar was largely offset by a similarly rising US Treasury curve. Given these developments, and our expectation that the BoC will now be overtaken by the Fed in the 2022 hiking race, we think the Canadian dollar remains susceptible to further downside pressure.

Pullback in transportation costs offsets broad-based price increases




Jay Zhao-Murray, FX Markets Analyst

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