By Robb M. Stewart
OTTAWA--Canadian inflation cooled for a second month running to cap a year of easing price pressures for consumers as the effects of the pandemic continue to fade, leaving room for interest rates to fall further even as the country braces for U.S. President Donald Trump's threatened trade tariffs.
The consumer price index fell 0.4% in December, leaving inflation to ease slightly to a three-month low of 1.8% compared with a year earlier, Statistics Canada said Tuesday. That was in line with what economists were expecting and marks a fifth straight month annual inflation has been at or below the Bank of Canada's 2% target.
A temporary tax break introduced by outgoing-Prime Minister Justin Trudeau kicked in mid-December and was the biggest drag on inflation for the month. The tax holiday is likely to weigh on inflation until it ends in February, when the country could find itself hit by the protectionist trade policies of the new U.S. administration.
That muddies the picture for the Bank of Canada's governing council, which meets next week having already cut its policy interest rate at each its last five meetings and after it said it would look past policy-induced inflation swings to focus on underlying trends. For most economists, those trends appear benign enough to warrant another cut this month, and possibly more during the year given the threats to the economy.
Stripping out the effects of the tax holiday, annual inflation ticked up for December to 2.3%. And traditional core prices, which exclude volatile food and energy costs, climbed 2.1% over the last 12 months after 1.9% growth the month before.
Still, the measures of underlying inflation preferred by the Bank of Canada cooled. Trimmed mean and weighted median CPI climbed an average 2.45% annually, the slowest pace since September.
"The heavy overhang of trade uncertainty--possible U.S. tariffs--overrides almost all else. As a result, we suspect that today's [inflation] reading is just good enough to allow the Bank of Canada to trim next week for risk management purposes," said Douglas Porter, chief economist at Bank of Montreal.
The Trudeau-government's sales-tax break, which applies to items including toys and restaurant meals, affected about 10% of the items in the CPI basket. It meant Canadians last month saw the first annual price decline in food bought at restaurants and they paid less for alcoholic drinks. Prices for toys, games and hobby supplies also fell in December.
Statistics Canada will release retail sales data for November later this week. Its advance estimate points to flat trade for the month, which analysts expect reflected a delay in holiday-period shopping as households waited for the tax break to start.
Shelter costs rose at a slightly slower pace in December, though they remain elevated and are still the biggest contributor to overall inflation.
Gasoline prices were up in December, largely due to a tougher year-earlier comparison. And Canadians paid more for travel services last month as prices increased for travel tours and accommodations, the latter spurred higher by the Vancouver, British Columbia, leg of Taylor Swift's concert tour.
"There were plenty of temporary factors to weed through in the December CPI report, but beneath the surface inflationary pressures still appear benign," said Oxford Economics Economist Michael Davenport, who continues to expect the Bank of Canada will cut rates this month. Davenport estimates the tax holiday will cause inflation to slow further in January and February, before it rebounds above 2% in March.
Headline inflation has been inside the 1%-to-3% window the central bank seeks to maintain for a full year. It averaged at 1.9% for the final quarter of last year, softer than the 2.1% projected by the Bank of Canada.
The Bank of Canada's governing council last month lowered its benchmark interest rates by a half-percentage point, a second consecutive outsized move, but the council signaled a more gradual approach to monetary policy in the new year. Analysts widely expect rates to fall further this year, though the odds of the bank pausing next week rose with signs the economy strengthened in the fourth quarter and hiring accelerated in December.
Business sentiment remains subdued overall, though companies are beginning to anticipate improvements in sales activity, as shown in the latest Bank of Canada business survey, released this week. The quarterly report found inflation expectations have lifted, in part due to the threat of U.S. tariffs on goods imported from Canada, though most business continue to look for inflation to be inside the 1%-to-3% range over the next two years.
Uncertainty for Canada's economy is elevated after Trump on the day of his inauguration said he planned to impose 25% tariffs on goods imported from Canada and Mexico as early as Feb. 1. The president has pledged to make tariffs a top priority, deeming them a way for the U.S. to raise revenue and avoid extra taxes on Americans.
The threatened U.S. tariffs and retaliatory levies imposed by Canada would weigh on Canada's growth, likely pushing the country into recession, and would reignite price pressures.
That has Dominique Lapointe, director of macro strategy at Manulife Investment Management, expecting a quarter percentage point cut in rates next week and three further cuts during the year as the negative impact of U.S. trade policies forces the Bank of Canada's hand.
The Canadian central bank is scheduled to update its economic projections with the coming rate decision Jan. 29.
Write to Robb M. Stewart at robb.stewart@wsj.com
(END) Dow Jones Newswires
01-21-25 1301ET