Canada’s main measure of inflation dropped to its slowest rate in almost a year, a positive change, but one that will complicate the Bank of Canada’s decision on what to do with interest rates.

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Canada's inflation drops to slowest in almost a year, but underlying cost pressures stay strong Back to video

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Statistics Canada on Jan. 17 reported that the consumer price index increased 6.3 per cent from December 2021, down from 6.8 per cent the previous month and the smallest year-over-year increase since the index rose 5.7 per cent in February 2022.

The drop in the headline number was mostly the result of lower gasoline prices, though Statistics Canada noted its measure of the cost of replacing a home, fuel oil and various durable goods also decreased from year-ago levels. The index declined 0.6 per cent from November, pulled lower by a 13.1 per cent drop in pump prices; both were the largest month-to-month declines since April 2020, Statistics Canada said.

Bank of Canada governor Tiff Macklem last month said he’d be open to pausing interest rate increases if data showed Canada’s inflation fever had broken. Statistics Canada’s latest reading is inconclusive on that question, because while the numbers look good on the surface, some of the more granular readings suggest underlying cost pressures remain.

Excluding food and energy, volatile prices that exert outsized influence on the headline number, inflation rose 5.3 per cent from December 2021, down only marginally from 5.4 per cent in November. That suggests inflationary pressures remain strong, which could prompt the Bank of Canada to keep raising interest rates when it concludes its latest policy meeting next week.

“While inflation may be peaking and showing signs of moderating, it remains well above the Bank of Canada’s target of two per cent,” Charles St-Arnaud, chief economist at Alberta Central and a former Bank of Canada staffer, said in a note to clients.

While the drop in headline inflation “slightly reduced the odds of further rate hikes, it will not be enough to prevent the BoC from increasing its policy rate” by a quarter-point next week, he said.

The inflation numbers are the last significant figures policymakers will see before they decide whether to end — or at least pause — the most aggressive series of interest rate increases in its history. The Bank of Canada opened the door to a pivot in December, when it raised the benchmark rate another half-point, but also explicitly said its next move would depend on the data it received ahead of the next scheduled policy update on Jan. 25.

For most of 2022, the central bank’s leaders began each policy deliberation knowing they would be raising interest rates, making the debate about one question: how high? They would ratchet the benchmark rate all the way to 4.25 per cent, from 0.25 per cent in March. Most agree interest rates are nearing the limit of what the economy can bear, as the Bank of Canada’s own forecasts predict economic growth will stall over the months ahead.

Yet inflation remains well off the central bank’s target, and Macklem has vowed he will settle for nothing less than a return to two per cent. Earlier this month, Statistics Canada reported the economy added more than 100,000 jobs in December, and that the jobless rate dropped to five per cent, suggesting the economy still had lots of momentum at the end of the year, meaning interest rates would need to go higher still to crush inflation.

“Economic data has been a bit mixed,” Michael Greenberg, a portfolio manager at Franklin Templeton who predicts a quarter-point increase next week, said in an email. “Our view is the Bank of Canada might be a little more stubborn to ensure that inflation gets back to (target), and, more importantly, that inflation expectations from consumers and business remain anchored.”

Expectations are an important consideration for the Bank of Canada. Policymakers believe psychology is an important determinant of inflation. If companies and households think prices will rise, and make business and financial decisions accordingly, inflation becomes a self-fulfilling prophecy.

The central bank received discouraging news in this regard on Jan. 16, when its quarterly surveys of companies and consumers both showed that respondents doubted the central bank would get inflation back to two per cent in the short term. All things equal, that puts extra pressure on Macklem to raise interest rates next week to show he’s serious about hitting his target.

To be sure, expectations of the future tend to be influenced by the recent past, so the drop in prices from the fall could begin to change perceptions. The cost of durable goods increased 4.7 per cent from December 2021, compared with a year-over-year increase of 5.3 per cent the previous month.

Prices for household appliances declined 4.1 per cent from November, the biggest one-month drop on record, Statistics Canada said. The agency said upward pressure on the price of goods was beginning to ease because supply chains were returning to normal, shipping costs had declined and demand was starting to wane.

“Signs that underlying inflationary pressures are easing open the door to a pause,” but only after one more increase, St-Arnaud said.

• Email: kcarmichael@postmedia.com | Twitter: carmichaelkevin