A Stall in Canada’s Core Inflation Narrative

What a difference 5 months can make. Canada’s inflation trend has apparently transitioned from a steady decline to a stall. The last two months of failed progress looks like a bottoming process when compared to the previous trend. This stalling also confirms the Bank of Canada’s concern in July about the loss of the benefits of the base effects that helped drive the inflation trend downward. The chart below comes from Statistics Canada in its August CPI report.

Back in April, the Bank of Canada (BoC) described a goldilocks narrative on inflation. This narrative featured the annual change in the Consumer Price Index inflation (CPI) gradually returning to the 2% target at the end of 2024 with economic growth picking up alongside inflation’s downward glide path in 2024. Just two months later in June, the Bank of Canada raised concerns about stubborn inflation and on-going high excessive demand. Accordingly, the BoC took its finger off the pause button on rate hikes and wrote an insurance policy on inflation with one more rate hike. The latest stall in inflation’s trend caused market expectations of a rate hike in October to surge from 23% to 42%.

The Canadian dollar surged along with rate hike expectations. The Canadian dollar was already rallying against the U.S. dollar (USD/CAD) going into the inflation print despite the U.S. dollar’s strength against other major currencies. The chart below shows how the Invesco CurrencyShares Canadian Dollar Trust (FXC) gapped higher at the open but faded from the intraday high. While the intraday action may represent an element of sell on the news, I think the path of least resistance is higher for the Canadian dollar until some new inflation data contradicts the revival of inflation concerns. I sold a small position short on USD/CAD to take advantage of the small fade.

I am not expecting the Federal Reserve’s coming announcement on monetary policy to change the trajectory. Accordingly, I will add to my position if USD/CAD rebounds further.

Drivers of Core Inflation

Core inflation was supported by accelerating rent prices. Ironically, Statistics Canada partially blamed high mortgage rates which are of course higher thanks to the BoC’s rate hikes to fight inflation:

“Shelter prices were up 6.0% on a year-over-year basis in August, after increasing 5.1% in July. Faster growth in shelter prices was led by the rent index, which rose 6.5% year over year nationally, after a 5.5% gain in July. Among other factors, a higher interest rate environment, which may create barriers to homeownership, put upward pressure on the index.”

Presumably, the higher mortgage rates are forcing more people than usual to choose renting over buying and in turn pressuring vacancy rates. Lower vacancy rates tend to push rent prices higher.

I might next need to write about a Canadian inflation conundrum!

Be careful out there!

Full disclosure: short USD/CAD

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