Inflation fell sharply last month. Will we see spring rate cuts?

The annual rate of inflation across the country eased half a percentage point in January, an unexpected drop that could mark a “pleasant surprise” for consumers and the Bank of Canada alike.

The overall inflation rate was 2.9 per cent in January, the agency said Tuesday. That’s down from 3.4 per cent in December, when it accelerated slightly from the previous month.

Driving the decline were gas prices which fell for the fifth consecutive month, StatCan says. A pause to the provincial gas tax in Manitoba contributed to the decline.

Price growth at the grocery store also cooled significantly, up 3.4 per cent in January compared to 4.7 per cent in months previous. While StatCan says the cooling in food inflation was “broad-based” across aisles in the grocery store, some items including shrimp and prawns, soup and bacon saw year-over-year price drops.

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Airfares were cheaper on an annual basis – down 14.4 per cent in January compared with 9.7 per cent in December – and consumers were also paying less for clothing last month, according to StatCan.

Cellular services prices ticked back up on a monthly basis following the end of promotional campaigns in November and December, the agency said.

StatCan noted that January marked the first month-to-month decline in the overall consumer price index on a seasonally adjusted basis – the first time this has happened since the start of the COVID-19 pandemic almost four years ago.

The Bank of Canada rapidly raised its benchmark interest rate from rock-bottom lows starting nearly two years ago in an effort to take steam out of the economy and tame inflation. The annual inflation rate has cooled significantly from highs of 8.1 per cent in June 2022.

Prime Minister Justin Trudeau called the drop in inflation a “piece of good news” while speaking in Vancouver on Tuesday.

1:23 Trudeau ‘optimistic’ BoC will bring down interest rates this year

He said that the annual inflation rate was now in the Bank of Canada’s “target” range. The central bank sets its inflation target at two per cent – the midpoint of a one-to-three per cent range – in its efforts to restore price stability.

Policymakers at the Bank of Canada have made clear they will not be satisfied until inflation cools all the way back to two per cent, though easing in the central bank’s policy rate could come before that point.

Trudeau said Tuesday that Ottawa is “optimistic that the Bank of Canada will start bringing down interest rates sometime this year, hopefully sooner rather than later.”

“But that is their decision to make,” he said.

Economists had expected inflation cooled in January, but not necessarily this much.

Tu Nguyen, economist with RSM Canada, tells Global News that the January inflation report was a “pleasant surprise.”

“It was good news for consumers, for businesses and for the Bank of Canada,” she says. “I think that this January report shows that we’re heading in the right direction.”

1:49 Economists expect spring interest rate cut after Bank of Canada holds steady

BMO chief economist Doug Porter said in a note to clients on Tuesday that a cool start to the year for price hikes can send a vital signal for the rest of 2024.

“January can set the tone for inflation, since firms often take the opportunity to adjust prices for the year in this month—and there was little sign of a big January bump this year,” he wrote.

The Bank of Canada is looking for signs inflation will continue to ease all the way to its two per cent target as it gauges when it might begin discussing cuts to its benchmark interest rate.

The central bank’s preferred measures of core inflation also eased in January.

Andrew DiCapua, senior economist at the Canadian Chamber of Commerce, told Global News on Tuesday that he expects the Bank of Canada will want to see more months of data showing a consistent easing in core inflation before it’s ready to cut interest rates.

But amid signs of progress elsewhere in the inflation fight, housing costs are continuing to plague consumers.

Shelter inflation accelerated to 6.2 per cent in January, up from 6.0 per cent the month previous, as rising rents and mortgage interest costs continue to put pressure on households.

Nguyen says that, stripping out the shelter component, annual inflation would be back at 1.5 per cent. Without mortgage costs, inflation is right at two per cent, she adds.

“That’s exactly on target. So we can see that monetary policy in the overall economy is working exactly as intended in restoring price stability,” Nguyen says.

Bank of Canada officials have said recently that monetary policy cannot tame shelter inflation amid structural housing shortages in the country.

1:41 BoC monetary policy targets inflation, not housing: Macklem

But the central bank can’t just ignore the impact of shelter inflation, even price impacts tied to its own interest rate hikes, Nguyen says.

Shelter costs will likely rise no matter what the Bank of Canada does, she argues; a rate hold keeps rents and mortgage pressure high while cuts spur activity in the housing market.

“The question for the bank moving forward would be how much they want to factor in housing and housing prices … when making their decisions,” Nguyen says.

“I think housing will continue to be a big puzzle in the Bank’s decisions.”

The soft January inflation print comes after a surprisingly robust jobs report for the same month on Feb. 9, which saw the unemployment rate tick down and wage growth remain strong.

Porter said Tuesday that the Bank of Canada “will likely remain cautious” in the face of the resilient labour market and core inflation holding above three per cent.

He added that the latest inflation data “makes rate cuts much more plausible in the coming months,” but noted BMO is holding to its call for a first rate cut in June.

Nguyen says that with most of the job gains concentrated in part-time work, the Bank of Canada will likely view the latest labour market report as more proof that the economy is not really growing at the moment.

If inflation meanwhile continues to trend in the right direction, that could give the central bank “leverage” to cut interest rates earlier and stimulate the economy, Nguyen says, though like Porter she sees a June rate cut as the most likely scenario.

1:49 Economists expect spring interest rate cut after Bank of Canada holds steady

DiCapua says the Bank of Canada may have the “luxury” of holding rates where they are for longer if the labour market remains buoyant but could pivot to earlier rate cuts if the wider economy starts to show cracks.

“If the economy tilts a little bit more negative in terms of optimism, consumer spending, and we see a little bit of a pullback both in the economy and the labour market, they may be forced to act a little bit sooner,” he says. “But at this point we’re expecting rates to come down in the spring.”

Money markets on Tuesday raised the odds of a rate cut in April to 58 per cent, according to Reuters, up from 33 per cent before the latest inflation figures.

The next interest rate decision is set for March 6.

– with files from Global News’ Anne Gaviola