Introduction:
The recently released October Consumer Price Index (CPI) report for Canada has taken analysts by surprise, revealing milder inflation than expected at 3.1% year-on-year. This blog post delves into the key findings and implications of the report, highlighting critical factors shaping the economic outlook.
A Closer Look at Canada's Economic Landscape
The October Consumer Price Index (CPI) reading turned out to be milder than anticipated, coming in at just 3.1% year-on-year (as opposed to the expected 3.2%). Notably, the headline index experienced a 0.1% month-on-month decline on a seasonally adjusted basis, marking the first monthly decrease since the onset of the pandemic in early 2020.
The primary factor contributing to the monthly decline was a 6% drop in gasoline prices. However, even when excluding this factor and examining core inflation, which the Bank of Canada closely monitors, there was a significant deceleration from 4.0% to 3.8%. With inflation falling, coupled with a softening labor market (a 0.7% rise in the unemployment rate over the past 6 months) and a weakening economic growth forecast (Q3 expected to be flat), it is highly probable that the Bank of Canada will maintain its current stance.
In fact, markets are currently factoring in a pause from the Bank of Canada only until the April meeting next year, before potential rate cuts commence. This is a notable shift, as earlier in the month, markets were not anticipating the first cut until the latter half of the following year. It would require substantial changes for the Bank of Canada to shift from its current "pause" mode, as the data does not support future interest rate hikes.
Governor Macklem emphasized the effectiveness of the current monetary policy in a recent speech, stating that interest rates may now be sufficiently restrictive to restore price stability. Despite such assertions, there is skepticism given the governor's past statements and the unpredictable nature of economic forecasting. The current outlook suggests that interest rates will remain low unless there are significant and unforeseen changes.
The pressing question now is when the Bank of Canada will decide to cut rates. As mentioned in the previous month's analysis, a crucial factor is the decline in inflation expectations, (to know more from the BoC click the link here). Until these expectations decrease to at least 3%, rate cuts are highly unlikely. Additionally, the Bank of Canada faces a dilemma, as cutting rates too aggressively compared to the Federal Reserve could impact the Canadian dollar and potentially lead to increased inflation through more expensive imports.
This situation is further complicated by the resilient nature of the U.S. consumer, who shows no signs of slowing down, benefiting from locked-in low rates for 30 years and lower overall debt burdens compared to Canadians. Ultimately, the actions of U.S. consumers may play a significant role in determining Canadian interest rates, irrespective of the state of the domestic economy—a somewhat unsettling prospect.
