Even though inflation is showing signs of significant cooling, the Bank of Canada is warning that progress might not be enough to prevent further interest rate hikes.
The annual rate of inflation fell to 4.3 per cent in March, Statistics Canada said Tuesday.
That marks the lowest level for annual inflation since August 2021 and a sharp slowdown from the 5.2 per cent seen in February.
Canada’s annual inflation rate has been steadily declining since last summer, as global price pressures ease and high borrowing costs weigh on spending.
Inflation is expected to continue slowing in the coming months, with many economists including the Bank of Canada forecasting the annual rate to fall to about three per cent by mid-year.
Bank of Canada governor Tiff Macklem told MPs at the House of Commons finance committee on Tuesday that March’s drop in inflation was “good news,” but maintained his recent warnings that recent progress on inflation does not mean the central bank is out of the woods yet.
He said the Bank of Canada’s policymakers are still considering whether interest rates have risen enough to make sure inflation gets all the way back down to the central bank’s two per cent target.
“We can’t rule out that interest rates may need to go higher to get inflation back to target,” he said.
One of the major risks Macklem identified here was that inflation on services like travel and dining out could remain “stickier” even as pressures on goods starts to abate. Canada’s tight labour market, which has shown few signs of easing with an unemployment rate of 5.0 per cent through 2023 to date, is a big factor underpinning this risk, he said.
TD Bank senior economist Leslie Preston also highlighted this risk in a note to clients on Tuesday.
“Persistently” high levels of inflation here means the Bank of Canada will have to “remain vigilant to inflation pressures, and may need to hike again if momentum in the domestic economy does not cool as expected,” she wrote.
Andrew Grantham, executive director of economics at CIBC, said in a note Tuesday that he expects inflation will “likely stall” around 2.5-3.0 per cent by the end of 2023.
“That should be low enough to prevent a further interest rate hike from the Bank of Canada, but not yet to a level at which policymakers will feel confident about easing interest rates,” he wrote, calling for cuts to the policy rate to begin in 2024.
While possibly stubborn services inflation is one risk that could keep prices higher for longer for Canadians, Macklem also highlighted that the possibility of a steeper than expected economic downturn — a sharp global recession — would bring prices down in a hurry if it materialized.
Modest relief continues at the grocery store
In a sign that Canadians are still prepared to spend for services, the prices for travel tours in March jumped a staggering 36.7 per cent from February, Statistics Canada said, the largest increase on record. In his note, Grantham pointed to pent-up travel demand coinciding with March break as driving up these prices.
Meanwhile, Statistics Canada said March was the second consecutive month to see year-over-year drops in prices at the gas pumps. But the agency noted much of the relief in the annual comparison was tied to the spike in gas prices in March 2022 tied to Russia’s then-nascent invasion of Ukraine.
The cost of food from the grocery store was up 9.7 per cent in March, representing a slight cooling from the 10.6 per cent seen in February. March marked the first time in eight months the grocery inflation figure clocked in below 10 per cent.
Statistics Canada pointed to lower prices for fresh fruit and vegetables as driving the modest relief. In particular, the agency said shoppers were finding lower prices for grapes, oranges, celery and cucumber last month.
Macklem also told MPs that businesses will need to stop passing on the higher costs they’re getting from suppliers directly onto consumers before inflation can effectively be tamed.
“When companies are not worried about losing customers, they just pass on those prices,” he said. “It’s starting to normalize but that’s something we need to watch closely.”
Mortgage pain adding to inflation
The rapid rise in the Bank of Canada’s interest rate, designed to cool inflation, has also compounded the pain and driven costs higher for some Canadians.
Specifically, mortgage interest costs rose 26.4 per cent in March — the largest yearly increase on record, Statistics Canada noted.
Canadians are today renewing their mortgages at much higher rates than a year ago, when the Bank of Canada first started raising its policy rate from the rock-bottom 0.25 per cent. A year later, the central bank’s benchmark rate stands at 4.5 per cent following one of the fastest policy tightening cycles in the institution’s history.
Growing mortgage stress was one of the major risks to the Canadian financial system flagged by the country’s banking watchdog on Tuesday.
The Office of the Superintendent of Financial Institutions (OSFI) said Tuesday in its latest annual risk outlook that the housing market is its top source of worry, as high rates mean higher default probabilities.
“OSFI is preparing for the possibility, but not predicting, that the housing market will experience sustained weakness throughout 2023,” said superintendent Peter Routledge on a media conference call.
Credit quality, however, so far looks quite strong and residential real estate remains sound, he said.
“What’s interesting now is how benign conditions have remained. Underlying that is a very strong economy, unemployment is still very low,” Routledge said. “And because of that, Canadians are servicing the higher cost of debt, quite handily.”
He added that the risk outlook is meant to remind everyone that while finances look strong, the risks are still out there.
— with files from The Canadian Press