Canada’s Consumer Price Index (CPI) in December came in at 1.8% year-over-year (yoy), lower than the expected 1.9%, and a decrease from the previous month’s 1.9%. According to Bank of America, the drop was attributed in part to the GST/HST tax holiday, which began on December 14 and is set to continue until February 15.
This tax break, which temporarily removes the Goods and Services Tax/Harmonized Sales Tax on certain items, affects around 10% of the CPI basket, including food purchased in restaurants and store-bought alcoholic beverages.
Core inflation measures also experienced a decline, with the average of the trimmed and median core measures falling to 2.45% yoy from November’s 2.60%. The median core inflation led at 2.4% yoy, followed by the trimmed mean at 2.5%. Despite the decreases, the core measures, which are adjusted for taxes, suggest some underlying easing, with services inflation remaining steady at 3.5% yoy and shelter inflation slowing slightly.
In light of the recent inflation data, BofA’s inflation forecasts remain largely unchanged, with expectations for inflation to stabilize at 2.0% yoy by the end of 2025 and 2026. However, the Bank of Canada (BoC) is now anticipated to cut interest rates by 25 basis points at its upcoming meeting on January 29, a shift from the previous stance of holding rates steady.
This expectation is driven by the continued fall in inflation, anchored inflation expectations, and weaker economic indicators from November 2024. Additionally, potential tariffs proposed by President Trump could influence the BoC to cut rates to support the Canadian economy and allow the Canadian dollar to act as a buffer.
Canadian rates rose across the yield curve following the CPI announcement, reflecting the market’s reaction to the likelihood of rate cuts and the potential imposition of tariffs. The market is currently pricing in an 84% chance of a BoC rate cut at the next meeting.
Furthermore, the risk of tariffs is leading to expectations of further BoC rate cuts to mitigate the impact on Canadian economic growth.
In the foreign exchange market, the Canadian dollar saw little movement post-CPI release, as the anticipated BoC rate cut was already factored in. However, the possibility of the US implementing a 25% tariff has brought volatility to the USDCAD exchange rate, which remains below 1.45.
The outcome of the tariff situation and the BoC’s response could influence the USDCAD pair to break above this level and potentially move towards a 1.50 range, depending on further policy rate adjustments by the BoC.
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