Inflation hits lowest level since August 2021, but BoC not expected to back off yet

OTTAWA — The Bank of Canada is expected to keep interest rates elevated for some time even as the country’s annual inflation rate falls rapidly.

Inflation in Canada dropped to 4.3 per cent in March, Statistics Canada said in its latest consumer price index report released Tuesday.

The headline rate eased from 5.2 per cent in February as higher mortgage interest costs were offset by lower energy prices.

The country’s annual inflation rate is mostly tracking along the Bank of Canada’s forecast of reaching three per cent by mid-year. Its preferred measures of core inflation, which the central bank uses to look through volatility in prices, also trended downward in March.

“Today’s report shows that all roads do indeed point to three per cent inflation in the months ahead,” said BMO chief economist Douglas Porter in a client note.

The continued slowdown in inflation since last summer has now brought the annual rate down to the lowest it’s been since August 2021.

But the Bank of Canada has said it won’t rest until inflation gets back to its two per cent target, even if the deceleration in inflation has been encouraging. That means expect interest rates to stay high for the next while.

While testifying at the House of Commons finance committee on Tuesday, governor Tiff Macklem acknowledged that the latest CPI report shows inflation is heading in the right direction.

“We are encouraged by that, but we are also seized with the importance of staying the course and restoring price stability for Canadians,” Macklem told MPs.

The central bank is particularly concerned that getting from three to two per cent might take a while. According to its latest forecasts, the Bank of Canada is expecting inflation to return to its two per cent target by the end of 2024.

The central bank’s concern about sticky inflation largely stems from persistently high wage growth and service price inflation.

In March, service prices were up 5.1 per cent from a year ago. Meanwhile, wages were 5.3 per cent higher than a year ago, growing at a faster pace than inflation.

In a client note on Tuesday, TD managing director and senior economist Leslie Preston said the latest data speaks to the challenges Macklem has highlighted.

“The Bank of Canada needs to remain vigilant to inflation pressures, and may need to hike again if momentum in the domestic economy does not cool as expected,” Preston said.

At its last interest rate decision on April 12, Macklem addressed speculation that the central bank would move to cut rates toward the end of the year. He said that didn’t look like “the most likely scenario.”

Instead, the central bank has signalled interest rates may have to stay higher for longer to get there. Its key interest rate currently sits at 4.5 per cent, the highest it’s been since 2007.

In the months to come, the headline rate is expected to continue to fall rapidly in part due to base-year effects. A base-year effect refers to the impact of price movements from a year ago on the calculation of the year-over-year inflation rate.

Porter said base-year effects explains part of the deceleration last month, noting March 2022 saw the fastest monthly increase in prices in three decades.

But the deceleration hasn’t brought much relief to homeowners with new mortgages or renewing their mortgages at high interest rates. Mortgage interest costs rose at the fastest pace on record last month, up 26.4 per cent from a year ago.

Grocery prices are also still rising rapidly, but at a slower pace. Grocery prices were up 9.7 per cent on a year-over-year basis in March, down from 10.6 per cent in February. Statistics Canada said the deceleration was driven by lower prices for fruits and vegetables.

Economists have long been expecting slower price increases up the food supply chain to filter down to slower prices increases at grocery stores.

“I don’t think we’re gonna get a lot of relief from from high prices, they just won’t be rising as quickly as what we’ve seen over the past year,” Porter said.

This report by The Canadian Press was first published April 18, 2023.

Nojoud Al Mallees, The Canadian Press