Despite the recent drop in inflation to its lowest level since August 2021, it is unlikely that the Bank of Canada will ease off its current stance.

The Bank of Canada is likely to maintain high interest rates despite a significant drop in the country's annual inflation rate. Statistics Canada's latest report on consumer price index showed that inflation in Canada fell to 4.3% in March from 5.2% in February. Although the country's annual inflation rate is expected to reach three per cent by mid-year, the Bank of Canada will continue to keep interest rates elevated until inflation reaches its two per cent target.
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March 2023 Inflation Rate in Canada: 4.3%

The Bank of Canada is expected to maintain elevated interest rates for an extended period despite the significant drop in the country’s annual inflation rate. Statistics Canada’s latest consumer price index report released on Tuesday revealed that inflation in Canada fell to 4.3% in March, down from February’s 5.2%, as lower energy prices offset higher mortgage interest costs. The annual inflation rate is following the Bank of Canada’s prediction of reaching 3% by mid-year. Its preferred measures of core inflation, which the central bank uses to look through volatility in prices, also decreased in March.

BMO Chief Economist Douglas Porter stated in a client note that the report shows that all roads point to three percent inflation in the coming months. Despite the continued slowdown in inflation since last summer, bringing the annual rate down to its lowest level since August 2021, the Bank of Canada will not relax until inflation returns to its 2% target. Thus, high interest rates are expected to remain in place for the time being.

While testifying before the House of Commons finance committee on Tuesday, Governor Tiff Macklem acknowledged that the latest CPI report indicates inflation is moving in the right direction. Macklem told MPs that “we are encouraged by that, but we are also seized with the importance of staying the course and restoring price stability for Canadians.”

The Bank of Canada’s concern about sticky inflation mainly stems from persistent high wage growth and service price inflation. In March, service prices were up 5.1% from a year ago, and wages grew at a faster pace than inflation, up 5.3% from a year ago. According to its latest forecasts, the Bank of Canada expects inflation to return to its 2% target by the end of 2024.

TD Managing Director and Senior Economist Leslie Preston stated in a client note on Tuesday that the latest data highlights the challenges Macklem has pointed out. Preston said, “The Bank of Canada needs to remain vigilant to inflation pressures and may need to hike again if momentum in the domestic economy does not cool as expected.”

Inflation To Its Lowest Level Since August 2021

At its last interest rate decision on April 12, Macklem addressed speculation that the central bank would cut rates toward the end of the year. He stated that did not appear to be “the most likely scenario.” Instead, the central bank signalled that interest rates might have to remain higher for longer to get there. Its key interest rate is presently at 4.5%, the highest it has been since 2007.

The headline rate is anticipated to fall quickly in the coming months, partly due to base-year effects. A base-year effect refers to the impact of price movements from a year ago on calculating the year-over-year inflation rate. Porter stated that base-year effects explain part of last month’s deceleration, noting that March 2022 saw the fastest monthly price increase in three decades.

However, the deceleration has not provided much relief to homeowners with new mortgages or those renewing their mortgages at high-interest rates. Mortgage interest costs rose rapidly on record last month, up 26.4% from a year ago. Although grocery prices are still increasing rapidly, they are increasing slowly. In March, grocery prices rose 9.7% year-over-year, down from February’s 10.6%. Statistics Canada stated that the deceleration was driven by lower prices for fruits and vegetables. Economists have long predicted that slower price increases up the food supply chain would eventually filter down to slower price increases at grocery stores.

Porter stated that he does not believe that high prices will provide much relief, but they will not rise as rapidly as they have over the past year.

Vik Palan

Vik Palan

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