Many economists are now bracing for a pause in the Bank of Canada’s rate cutting cycle following this morning’s stronger-than-expected inflation data. Money markets are also pricing in slightly higher odds that the bank will keep its key interest rate unchanged at its next policy meeting in April.
Canada’s annual inflation rate showed a surprise jump to 2.6% in February, surpassing expectations of 2.2%, as a sales tax break that ended mid of last month pushed prices higher amid an already broad-based price increase.
It was the first time in seven months that the rate of increase of consumer prices have crossed the 2% mark, the mid-point of the Bank of Canada’s 1% to 3% target range. In January, inflation was at 1.9%.
Without the tax break, inflation in February would have been 3%, Statistics Canada said.
Traders modestly added to bets that the Bank of Canada would keep its overnight rate unchanged at its next policy meeting on April 16. Money markets are now pricing in about a 65% probability of no rate change at that meeting, versus 62% prior to the data release.
Here’s how implied probabilities of future interest rate moves stood in swaps markets moments after the inflation report, according to LSEG data. The overnight rate now resides at 2.75 per cent. 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.
And here’s what they looked like just prior to the 830 am ET data:
Here’s how economists and market strategists are reacting in written commentaries:
David Rosenberg, founder of Rosenberg Research
Even on a seasonally-adjusted basis, the CPI leapt ahead by +0.7% MoM in the hottest month since June 2022, when inflation was all the rage. ... Our favorite inflation barometer, which is the CPIX (excluding the 8 most volatile items and indirect taxes) also rose by +0.4% MoM for the second month in a row and effectively ended a string of benign numbers that started in May 2023. The core (ex-food and energy) that strips out sales tax distortions also rose nearly +0.3% MoM on top of a +0.5% bounce in January. The increases in consumer prices were so broadly based that, try as we may, there were no identifiable special factors at play: services (+1.2% MoM), durable goods (+0.7%), non-durable goods (+0.7%), and semi-durables (+1.5%) all rose. When we seasonally adjust these various components, the story, sadly enough, doesn’t change. ...
The Bank of Canada now has a green light to start skipping some meetings — especially with the Fed on hold and the policy rate already some -150 basis points below U.S. levels — which is not so good for the GoC bond market but should help underpin the Canadian dollar over the near-term.
Royce Mendes, managing director and head of macro strategy at Desjardins Capital Markets
Given the tariff-related rise in inflation expectations and the recent momentum in actual price growth, it now seems likely that the Bank of Canada will pause its rate cutting cycle in April, at least temporarily. Officials debated whether to hold rates steady earlier this month, but ultimately chose to lower the policy rate another 25 basis points. Still, the decision to ease came with a stark warning that further cuts were not a foregone conclusion. With price growth likely to accelerate in the months to come as a result of retaliatory tariffs and past currency depreciation, now seems like the right time for the Bank of Canada to take a hawkish detour, driving home the point that containing inflation remains the central bank’s number one job.
Derek Holt, vice-president, Scotiabank Economics
Canadian inflation spiked higher and further reduces prospects for additional rate cuts by the Bank of Canada. ... The end of the GST/HST cut was only a modest part of the explanation. The bigger issue is that the BoC’s preferred core readings—that exclude taxes—were hot again.
USDCAD shook it off but that was because the impact of Canadian data coincided with stronger than expected US data for housing starts, industrial output and import prices. Canada’s two-year yield climbed only 1–2bps and may not have understood the drivers. Under a third of a 25bps rate cut is priced for the April meeting and is probably too much.
The BoC’s preferred core measures of inflation ... is no flash in the pan. They show the readings in month-over-month terms at a seasonally adjusted and annualized rate in order to capture inflation pressures using the most timely measures. They are simply too hot and have been too hot in a long stretch back to last May. The longstanding trend points to readings that are clearly saying that the BoC’s work is not done. They question why the BoC - an inflation-targeting central bank - has been in such a rush to cut to 2.75% for 275bps of easing to date.
Charles St-Arnaud, chief economist, Alberta Central
Overall, the report confirms that inflationary pressures have increased in recent months, and the GST holiday has obscured the true extent of these pressures. It is now clear that inflationary pressures are sticky, and prices have increased faster in recent months than the BoC would like to see, with the momentum in various core measures above 3%.
The rising and broadening inflationary pressures are complicating the BoC’s task and its responses to US tariffs, as they reduce its ability to cut rates in response to a slowing economy. It also means that the likelihood of the BoC cutting rates in April is significantly reduced.
Stephen Brown, deputy chief North America economist, Capital Economics
Indeed, the bad news for the Bank was that CPI-trim and CPI-median once again rose by an average of 0.3% m/m, which caused the average three-month annualised rate to tick up to 3.3%. Moreover, with shelter prices rising by a softer 0.2% in February, the Bank cannot continue to blame them for keeping its preferred core inflation measures elevated, with the average annual rate now at 2.9%. The upshot is that, despite the downside risks to the economic outlook from US tariffs, we may need to revisit our view that the Bank will cut interest rates again as soon as next month.
Matthieu Arseneau and Kyle Dahms, economists with National Bank
The data published this morning by Statistics Canada is enough to shake observers’ convictions about the inflation situation in the country. An acceleration of inflation was certainly inevitable in February with the end of the GST holiday in the middle of the month, which will also have an upward impact in March. To get a more accurate picture of the situation, we have been focusing on inflation measures excluding indirect taxes for some months now. In February, the CPI excluding indirect taxes increased by a whopping 0.4% and the annual rate is now 2.9%, which is close to the upper limit of the Bank of Canada’s target range. On an annualised three-month basis, this measure stands at 5.1%, its highest rate since September 2023. There are certainly specific factors to mention, notably travel tours surging (+23% y/y). But that does not mean that inflation was not widespread in February, as evidenced by the central bank’s preferred core inflation measures, which have been growing at rates of 0.3% m/m and annualized rates that exceed the Bank of Canada’s target range over the past three months (CPI-Median at 3.4% and CPI-Trim at 3.3%). We have repeatedly argued that these measures were skewed upwards by the housing component and that care should be taken in their use. But this was no longer the case in February, as monthly inflation in the housing sector had essentially returned to its historical average during the month. This bias led us, as well as the central bank, to focus on the diffusion recently, which is not a concern over a year but is enough to raise eyebrows over the last three months with no less than 35 components moving above the target of 2.0% at an annualised rate (average 1999-2019 at 27). There is no doubt that the Bank of Canada was surprised by the recent price developments in a context where the economy had started to improve. In such a context, there is a strong chance that the rate cut we were expecting in April will not materialise unless the economy deteriorates very rapidly in a context of tariff uncertainty. It remains that inflation is a lagging indicator, and the central bank may once again focus on economic variables that could weaken rapidly in the coming months if there is no improvement in trade relations with the United States. That scenario would justify lower path for the policy rate.
Benjamin Reitzes, managing director, Canadian rates and macro strategist, BMO Capital Markets
This report will reinforce the BoC’s cautious tone on easing to mitigate the impact of tariffs. Note that the coming end of the carbon tax will pull inflation down sharply in April, but March could see more upside as the rest of the tax holiday impact reverses. There’s plenty of noise still to come on inflation, complicating policymakers’ job. We’ll see what early April brings on the tariff front, but if the economic outlook doesn’t deteriorate further, the BoC will be considering a pause after cutting at seven straight meetings.
Katherine Judge, senior economist with CIBC Capital Markets
The upward pressure on the BoC’s core measures, as well as CPIX, is worrisome especially since this doesn’t reflect the impact of tariffs yet, even if it includes the impact of the depreciation in the Canadian dollar. We await news on the April 2nd reciprocal tariff date and if a 25% tariff is avoided, the BoC will likely pause at the April meeting to gauge CPI pressures ahead.
Claire Fan, senior economist, Royal Bank of Canada
The increase in year-over-year CPI reading in February was mostly a result of the end to a temporary GST tax holiday. At 2.6%, however, the headline reading is significantly higher than 1.9% in November before the tax holiday started, and suggests signs of moderately building underlying inflation pressures during this period. As much as those signs are alarming, they’re too early to be tariff related and are more likely a product of gathering strength in consumer spending since late last year. Moving forward, headline inflation will continue to be influenced by one-off factors as retaliatory Canadian import tariffs increase import costs but the removal of the consumer carbon tax lowers prices particularly for energy products starting in April. Today’s numbers won’t have been a surprise to the BoC – the central bank expected inflation to be 2.5% in March once the GST holiday is fully out of the data. The readings will, however, continue to complicate the central bank’s interest rate decisions. When cutting the overnight rate by another 25 basis points in March, the central bank said explicitly support of lower interest rate should not be at the cost of sacrificing the longer-run 2% inflation target. We expect the BoC will take into account all these moving parts, including the potential new round of broader “reciprocal” tariffs that the U.S. administration threatened against all trade partners for April 2 when making the next decision in April.
Dustin Reid, chief strategist, fixed income at Mackenzie Investments
The February numbers represent a challenge going forward for the Bank of Canada. With the end of the government’s GST holiday on about 10 percent of the CPI basket mid-month, the BoC will be debating how much to look through the numbers, which for some will be seen as a one-off.
We believe the BoC is poised to raise its neutral rate range in April to 2.50-3.50 percent from 2.25-3.25 percent and the BoC wants to be at the bottom - or very close to the bottom - of that range ahead of any significant tariff fallout from the US. With the BoC’s main policy rate now sitting at 2.75 percent, we believe the Bank could be close to done this part of the easing cycle - potentially putting a cut at the April meeting in doubt thanks in part to the surprisingly high inflation numbers - but would not hesitate to go below the bottom end of its neutral range if tariffs were seen as a medium-term risk to the Canadian economy.
Leslie Preston, managing director and senior economist, TD Economics
Headline inflation was a little hotter than expected as the sales tax holiday came to an end. However, the three-month annualized trend in core inflation has been tracking above 3%, signaling that core inflation should continue to grind higher. Our Quarterly Economic Forecast published today shows core inflation rising next quarter as tariffs contribute to price pressures.
This puts the BoC in a difficult place. Canadians’ inflation expectations have risen, but the hit to demand from uncertainty and the tariffs themselves are already weighing on demand. How tariffs play out remains highly uncertain. Our forecast assumes elevated U.S. tariffs over the next six months, and then gradual reductions. In this world, we expect the Bank of Canada to provide some further cushion in the form of two more 25 basis point rate cuts at its next two rate announcements.
David Doyle, head of economics at Macquarie
Should strong underlying inflation data persist for March, it may ... lead the BoC to temporarily pause the rate cutting cycle. However, we suspect that trade policy uncertainty and struggles in housing and the labour market are likely to lead the BoC to look through a temporary rise in inflation. As a result, we continue to anticipate three 25 bps ahead in each of April, June, and July with the Overnight rate reaching 2.0%.
Tu Nguyen, economist with national assurance, tax and consultancy firm RSM Canada
The increase from 1.9% in January is unsurprising but greater than expected. Core inflation measures also climbed, showing some inflationary pressures remaining.
Nonetheless, this is still the calm before the storm. March and April will see the Consumer Price Index increase even further, as the tax break will fully be gone, and especially because these months will reflect the impact of tariffs. Earlier this month, the US government imposed broad-based tariffs on all Canadian imports not currently covered under CUSMA, and the Canadian government retaliated with tariffs on select US imports. Some of these price increases in imports will be passed on to consumers and show up in the CPI index in the upcoming months.
The cancellation of the consumer carbon pricing will unlikely lead to a noticeable decrease at the pump since gasoline prices climbed over time with the gradually increasing carbon pricing. Now, it will take time for gasoline prices to drop.
Nick Rees, head of macro research. Money Canada (foreign exchange firm)
Taken together, we think there is plenty in this latest data to warrant caution from the BoC. Policymakers will be hoping that the coming month brings further clarity on the underlying cause of this inflation uptick, ahead of a rate decision on April 16th. Our macro base case remains that tariffs are likely to increase price pressures in short term, before the knock-on impacts for growth ultimately kill off consumer demand and inflation. But absent clear evidence of this playing out, the balance of risks increasingly favours the Governing Council leaving rates unchanged next month, supporting the loonie ahead of tomorrow’s FOMC meeting.
With a file from Reuters