Money market traders have modestly pared bets that the Bank of Canada will cut interest rates later this month following slightly hotter-than-expected inflation data Tuesday morning, the last major report before its Oct. 29 decision.
Canada’s annual inflation rate increased to 2.4% in September, mainly led by a smaller decline in gasoline prices on a yearly basis when compared with the previous month and a rise in food prices, Statistics Canada said on Tuesday.
Analysts polled by Reuters had forecast the annual inflation rate to rise to 2.3% in September from 1.9% in August.
The CPI rose 0.1% month over month in September from a decline on 0.1% in August. Excluding gasoline, the CPI rose 2.6% in September following a 2.4% acceleration in August.
Canada’s two-year bond yield, which is sensitive to central bank policy moves, rose about 3 basis points to 2.378% in the wake of the data.
Money markets are now placing about 77% odds of a quarter-point rate cut later this month, down from 87% just prior to the inflation report, according to LSEG data.
An unexpectedly strong labour report for September was released on Oct. 10, throwing doubt into whether the Bank of Canada would once again pull the trigger at its next policy meeting on Oct. 29. That report showed a surprise 60,400 net job gains for the month, prompting traders to put only about even odds on a quarter point rate cut at that meeting.
But since then, traders have been gaining confidence the bank will opt for a further cut, which would bring the Bank of Canada overnight rate down to 2.25%. A number of events were persuasive for this, including dovish-tilting remarks made by both Bank of Canada Governor Tiff Macklem and Federal Reserve Chair Jerome Powell, a growing consensus that the Fed will soon cut rates, credit market jitters involving U.S. regional banks, and the third quarter business and consumer sentiment surveys released Monday by the Bank of Canada that emphasized concerns about the labour market and the economy.
Here, in detail, is how implied probabilities of future interest rate moves stood in swaps markets after the 830 am ET inflation report. The current overnight rate is 2.50%, where it has stood since Sept. 17. While the bank moves in quarter-point increments, credit market implied rates fluctuate more fluidly and are constantly changing. Columns to the right are percentage probabilities of future rate moves.
Here’s what they looked liked just prior to today’s data:
Even if the Bank of Canada doesn’t cut rates at the end of this month, the data show money market traders are confident there will be a quarter point reduction in rates sometime by the end of this year. Whether there will be a further reduction beyond that, to the 2% level, is much more uncertain.
Here’s how economists are reacting in written commentaries this morning:
Andrew Grantham, senior economist, CIBC Capital Markets
“Headline CPI accelerated by more than anticipated in September, but core measures of inflation were just subdued enough to support a further 25bp cut from the Bank of Canada next week. … Measures of core inflation were likely subdued enough for the Bank of Canada to still reduce interest rates by a further 25bp next week, particularly given evidence of a sluggish recovery in GDP and weak business sentiment. The Bank has downplayed its previous preferred measures of core inflation recently (CPI-Trim and CPI-Median), instead using a wider range of indicators as well as measures of dispersion. Four measures of core inflation (CPI ex food/energy, CPI-X, CPI-Trim and CPI-Median) averaged 0.24% SA m/m, 2.3% on a 3m-annualized basis and 2.9% y/y. Those averages were broadly in line with the prior month, suggesting that while price pressures didn’t ease further there was also less evidence (relative to the headline) of a reacceleration. …
However, after [next week’s cut] the Bank is likely to move back onto the sidelines, in part due to evidence of some lingering inflationary pressures, but also on the assumptions that economic growth starts to recover and progress is made towards a trade deal that reduces some of the sector specific tariffs currently impacting Canadian trade.”
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Stephen Brown, deputy chief North America economist, Capital Economics
“The modest upside surprise to CPI inflation in September was largely due to higher food prices and a rebound in travel-related prices, rather than broad-based gains. Nonetheless, with September’s employment data also coming in a little hotter than expected, the CPI report does present a risk to our forecast that the Bank will cut interest rates again this month. …
The Bank’s preferred core measures, CPI-trim and CPI-median, continue to look a bit too strong for comfort, with the average monthly gain once again at 0.23% – i.e. above the 0.17% rate consistent with 2% annual inflation. The average annual rate was unchanged at 3.1%, although the Bank can take some comfort from the fact that the three-month annualised rate remains lower at 2.7%, up only slightly from 2.6% in August. Overall, there’s no clear message from the CPI, although we’re still leaning toward another rate cut this month following Governor Tiff Macklem’s somewhat dovish comments on the growth outlook last week.”
Royce Mendes, managing director and head of macro strategy, Desjardins
“Consumer prices posted surprisingly strong gains in September, but measures of underlying inflation suggest much less cause for concern. … Moreover, the distribution of price growth actually shifted somewhat lower. The share of categories with annual growth above 3% declined slightly to 39.5% from 41.0% in August, while the share of categories with price growth of less than 1% increased to 36.6% from 35.6%. Measures of both core goods and core services prices also suggest that underlying inflation remains in check.
After a careful review of the data, it looks like a few volatile categories drove the headline surprise. Given the Bank of Canada’s focus on underlying inflation, we believe that central bankers will choose to cut rates again next week. While there might be scope for debate about inflation, there should be no disagreement that the economy is weak and in need of support.”
Douglas Porter, chief economist, BMO Capital Markets
“We were all braced for a pop in headline to back above 2% on gasoline prices alone, but unfortunately food inflation got hungrier as well, with a few other elements of core also nudging into the picture. Suffice it to say this will make the Bank of Canada’s decision a bit more interesting next week than previously expected—markets had been all but baking in a rate cut after Governor Macklem’s dovish remarks and yesterday’s soft Business Outlook Survey. Absolutely full disclosure: We have been on the dovish side of the ledger, calling for the Bank to eventually cut the overnight rate to 2.0% (and possibly lower if trade gets uglier), but were not convinced that October would see another cut. Given today’s setback for core, we’ll stay there for now. The biggest counterpoint, as noted above, is that some key measures of core are still fully consistent with the Bank’s view that underlying inflation is around 2.5%.”
Michael Davenport, senior Canada economist at Oxford Economics
“September’s stronger-than-expected CPI inflation print raises the odds that the Bank of Canada will pause on October 29, but underlying inflation remains contained and with the economy struggling to grow and slack in the labour market, we expect another 25bp rate cut next week. … We still think the Bank of Canada is on track to cut the overnight rate by another 25bps to 2.25% – the low-end of its neutral range – next week. However, this will likely be as low as rates go this cycle as the BoC juggles elevated trade policy uncertainty, upside risks to inflation from a shifting global trade landscape, and major fiscal stimulus in the pipeline.”
Dominique Lapointe, director, macro strategy, for Manulife Investment Management
“In a different context, today’s print would give the Bank of Canada some pause to assess if this is the start of a new trend. However, it comes off the heels of two benign results (July and August). Without counter tariffs, with a relatively stable exchange rate and a large and growing negative output gap pushing down real wages, it will be difficult for the BoC to find persistent inflationary sources ahead. Considering that economic growth is close to 0 and that the unemployment rate is relatively high, we still think the Bank of Canada will cut one last time next week.”
More to come
