Canadian inflation is under control, as expected with the country’s unique modeling strategy. The Statistics Canada (Stat Can) Consumer Price Index (CPI) shows annual growth slowed in July. The quick slowdown was due in part to a circular reporting model, where central bank rate decisions have significant influence on the report itself. Slowing headline inflation is now expected to lead to 3 more rate cuts in 2024. With the unique reporting system, not used in other advanced economies like the United States, these cuts are likely to lead to slower inflation and potentially sharper cuts next year.
Canadian Inflation Climbed 2.5% In July, Slowest Annual Growth In 3 Years
Annual growth rate for the Canadian consumer price index (CPI).
Source: Statistics Canada.
Canadian inflation has been grinding lower as consumption slows across the board. Headline CPI fell 0.3 points to 2.5% in July, representing a 0.6 point decline from last year. This is the lowest rate since March 2021, and just 0.5 points above the Bank of Canada (BoC) target rate of 2.0 points.
Canadian Inflation Deceleration Led By Slowing Shelter Prices
Headline inflation is slowing due to shelter, the largest component in the basket. Annual growth came in at 5.7% in July, decelerating from the 6.2% reported a month prior. The agency attributed the slowdown to the major subcomponents—electricity, mortgage interest, and rents, which have all slowed. It’s probably worth remembering this component is still nearly 3x the target rate, emphasizing how much slower the other components must be.
The slowdown for car prices was also driving slower inflation last month. Car prices fell 1.4% over the 12-months ending in July. Annual price growth remained positive but slow for new vehicles (+1.0%), but fell sharply for used vehicles (-5.7%) over the same period.
Canada Uses A Circular Inflation Model Where Rate Decisions Directly Influence Inflation
Canadian inflation declined so rapidly partially due to the circular nature used in reporting. Stat Can includes mortgage borrowing costs in its basket, which are largely influenced by the BoC key interest rates. This leads to upward pressure on CPI when the central bank raises rates, and lower pressure when they cut rates. It’s a self-serving loop, resulting in the central bank’s decision being a key component in the direction inflation moves.
This isn’t the norm in other advanced economies. For example, the U.S. doesn’t include the cost of mortgage interest, arguing it would be silly to have a circular feedback loop that doesn’t accurately measure the cost of current consumption—which CPI is designed to measure. Instead, including the cost of borrowing reflects the contracted cost of consumption today, but not necessarily a real cost that will be incurred—either through refinancing or selling early.
Bank of Canada Forecast To Cut Rates 3 More Times In 2024
Understanding this model, it’s not hard to see why inflation is set to decline fast—and why a lot more rate cuts will arrive, circularly providing lower inflation.
“Inflationary pressures continue to fade, and were it not for the continued upward pressure from mortgage interest costs inflation would have been in-line with a 2% target in every month since the start of the year,” explains Andrew Grantham, an economist at CIBC.
In a brief written to investors, he explains the central bank will focus on its approach to downside risks to the economy, such as rising unemployment.
His bank now expects three more rate cuts by the end of the year. That would bring the policy rate to 3.75% by December. Much lower than the current level, but still higher than 2019 era interest rates.
Though those same cuts are also likely to shrink CPI shelter, and thus inflation—thus facilitating even lower interest rates.
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