Canadian inflation has achieved a significant milestone, remaining within the central bank’s target range for a full year for the first time since 2019. This accomplishment comes at a crucial time as policymakers face the looming threat of a potential tariff war that could jeopardize their progress.
According to Statistics Canada, the Consumer Price Index (CPI) recorded a modest annual increase of 1.8% in December, a slight decline from 1.9% the previous month. This result fell short of the 1.9% predicted by economists’ survey. Over the year, prices averaged a 2.4% increase in 2024, a notable decrease from the 3.9% rise seen in 2023.
The deceleration in inflation was largely driven by a decrease in prices for food from restaurants and alcoholic beverages. This drop is attributed to a sales tax exemption that was in effect from December 14 to February 15, affecting approximately 10% of the CPI basket. If these items were excluded from the calculations, the CPI could have potentially escalated to 2.3%, still aligning within the Bank of Canada’s target of 1% to 3%.
On a monthly basis, the CPI fell by 0.4%, which met economists’ expectations. In response to these developments, bonds rallied, with the yield on the two-year Canada benchmark note declining to 2.877%, marking the lowest intraday level in over a month.
Despite these positive inflation trends, the Canadian economy is experiencing significant uncertainty as U.S. President Donald Trump has announced intentions to impose tariffs as high as 25% on Canadian imports, set to take effect by February 1. Prime Minister Justin Trudeau’s government has committed to retaliatory measures, raising concerns about potential impacts on consumer prices and economic growth.
Should a trade war arise, the Bank of Canada might need to reevaluate its strategy regarding interest rate cuts to mitigate the effects on the economy. Governor Tiff Macklem has emphasized the importance of fostering strong economic growth, which has been underwhelming. The central bank will review its overnight benchmark rate on January 29, coinciding with an update to its economic forecasts.
A majority of economists anticipate that the Bank will ease its aggressive approach toward rate cuts, reverting to a more standard 25-basis point reduction next week.
“The Bank of Canada may need to reassess its inclination towards rate cuts in light of the imminent tariff threats. Even though inflation is moderating, there are indications that economic activity is picking up,” noted Andrew DiCapua, Senior Economist at the Canadian Chamber of Commerce. He added, “A weaker Canadian dollar could further amplify the cost impacts of new tariffs on the Canadian economy.”
While annual inflation continues to moderate, there are signs of sustained price momentum, with the headline CPI rising at an annualized rate of 2.8% over the past three months and core inflation measures averaging 3.6%, according to Charles St-Arnaud, Chief Economist at Alberta Central.
He cautioned, however, that “the main concern for the Bank of Canada lies not with inflation but with the potential economic risks stemming from reduced consumer spending, slowing population growth, and tariff threats. Therefore, we anticipate a possible 25-basis point cut at the January meeting.”
Among the Bank of Canada’s preferred core inflation measures, the annual average decreased to 2.45% in December from 2.6% the prior month. The CPI excluding gasoline saw a 1.8% increase, following a 2% rise in November.
Regionally, inflation rates softened in the Atlantic provinces and Ontario, driven in part by lower restaurant food prices, whereas Alberta experienced slower rent growth contributing to the overall deceleration.
In an effort to address rising cost-of-living concerns and regain voter support, Trudeau’s government introduced a federal sales tax holiday in November. The initiative, which exempts certain items from the goods and services tax, is estimated to cost C$1.6 billion (approximately $1.1 billion).
As the economic landscape continues to evolve, both policymakers and consumers will be keeping a close eye on upcoming developments.
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