Return to 2% inflation rate could be a bumpy one. Here’s why

Economists say inflation likely flared up again in February amid higher gasoline prices, reinforcing the expectation that the journey back to two per cent inflation will be a bumpy one.

Statistics Canada is set to release its February consumer price index report on Tuesday. The consensus expectation among forecasters is that prices rose 3.1 per cent from a year ago.

That would reverse some of the progress made in January, when the annual inflation rate slowed to 2.9 per cent.

“We’re looking for inflation to re-accelerate as a result of higher energy prices during the month. It looks like for the next few months, inflation will probably be bouncing around the three per cent range,” said Royce Mendes, managing director and head of macro strategy at Desjardins.

A rise in inflation will slightly complicate things for the Bank of Canada, which is widely expected to begin cutting its policy interest rate in the coming months.

But Mendes says what will be more important to watch on Tuesday are measures of underlying price pressures, which help economists gauge where inflation is headed.

“The real question is what’s going on underneath the surface,” Mendes said.

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At the Bank of Canada’s interest rate decision earlier this month, governor Tiff Macklem noted that almost half of the consumer price index components are currently rising at a pace above three per cent. In more normal inflationary times, only about a quarter of CPI components will rise that quickly.

The central bank has also emphasized trends in the economy and inflation over monthly reports.

At the same time, Macklem has stressed that the central bank does not want to cut interest rates prematurely and therefore will wait until there’s clearer evidence that inflation is headed back toward the bank’s two-per-cent target soon.

“This would be exhibit A from the (central) bank’s library as to why we have to be cautious,” said BMO chief economist Douglas Porter.

The Bank of Canada has held its key interest rate steady at five per cent since July, waiting for more evidence that inflation is getting closer to two per cent.

Its last projection suggested inflation would reach that target in 2025, a forecast many economists share.

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Porter says one source of uncertainty in these forecasts comes from energy prices, which typically have a significant effect on overall inflation.

“Oil prices can move mightily rapidly, and make a lot of inflation forecasts look pretty foolish,” he said.

Tuesday’s report will be the last inflation reading ahead of the Bank of Canada’s April interest rate announcement, which Porter called a “critical decision.”

Although the central bank is not expected to change its policy rate next month, many forecasters anticipate it will do so at the following decision meeting in June.

“I think if the bank is going to cut in June, they would have to deliver a fairly heavy signal in the April meeting,” said Porter.

However, the chief economist said the central bank can’t guarantee anything, since a lot can happen in two months.

The federal government is set to present its budget a week after the rate decision in April, which could affect the outlook for inflation. There will be two more months of economic data for the Bank of Canada to evaluate before its June decision.

“I think they would be very cautious in the language they use,” he said.