Inflation Is Cooling But Markets Still Pricing in an Additional Interest Rate Hike

Statistics Canada announced that Canada’s inflation rate fell to 4.3% in March from 5.2% in February—the slowest pace since August 2021. Any deceleration in inflation is welcome, but the 4.3% rate is still more than double the Bank of Canada’s two percent target.

On a month-over-month basis, the consumer price index (CPI) was up 0.5% after gaining 0.4% in February. Gasoline prices fell for the second straight month and are down 13.8% since the start of 2023, but food prices were still up 9.7% on an annual basis—that’s more than twice as fast as the overall inflation rate.

The cost of carrying a mortgage has helped push up the cost of living, with mortgage rate costs up 26.4% over the first three months of the year. This was the largest yearly increase on record and puts additional pressure on Canadian homeowners who are renewing and initiating mortgages at higher interest rates.

Where Are Interest Rates Going?

On April 12, the Bank of Canada said it was holding its benchmark interest rate at 4.50%. A move widely expected by analysts. While this helped buoy investor sentiment, the central bank played down any notion that it would be cutting rates this year.

Commenting on the stubbornly high inflation, Tim Macklem, Bank of Canada Governor said, “Inflation is coming down quickly—data this morning shows it fell to 4.3% in March.” The central bank expects inflation to cool by about three percent by mid-2023 and hit two percent by the end of 2024.

Macklem added that “Continued strong demand and the tight labour market are putting upward pressure on many services prices, and those are expected to decline only gradually.”

The hawkish tone has forced analysts to push forward any expectation of a rate cut into 2024. They even believe a further rate hike could be in order later this year. While there’s a greater than 80% chance that the Bank of Canada will not hike its key lending rate this year, there is a growing consensus (14.6% chance) that there will be a rate hike in 2023. That’s up from previous odds of a 9.4% rate hike.

The odds of an interest rate hike are not just contingent on what is happening in Canada; it’s based on both domestic and global economic conditions. It’s widely expected that the U.S. Federal Reserve will announce a quarter-point interest rate hike later this spring and no rate cuts until 2024. U.S. inflation was 5.0% in March and is expected to move to 5.125% in June.

This has increased the odds of a Bank of Canada rate hike this year as well. On top of that, Canadians will probably have to wait until 2024 to see actual cuts to interest rates.  

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