Canada’s annual inflation rate has returned to the Bank of Canada’s 2-per-cent target for the first time since 2021, a milestone for central bankers in their journey to restore price stability and a significant moment for the Canadian economy after the worst inflation surge in a generation.
The Consumer Price Index rose at an annual rate of 2 per cent in August, down from 2.5 per cent in July, Statistics Canada said Tuesday in a report. The result was a touch lower than analyst estimates of 2.1 per cent. On a monthly basis, consumer prices fell 0.2 per cent.
“It’s been a tough journey. We’re glad to see 2 per cent,” said Bank of Canada senior deputy governor Carolyn Rogers at an event in Toronto on Tuesday evening. “We want to see a sustainable return to 2-per-cent inflation. So that’s still to come.”
Canada’s inflation rate hit a four-decade high of roughly 8 per cent in mid-2022, part of a global upswing in prices that was spurred by many factors, including supply shocks tied to the pandemic and the invasion of Ukraine, abrupt shifts in consumer spending patterns and unprecedented fiscal stimulus during the health crisis.
Central bankers were caught off-guard by the persistence and strength of inflation – having incorrectly diagnosed it as “transitory” – opening up their credibility to attacks from politicians and consumers.
Pocketbook issues have also become a political liability for the federal Liberal Party, which is lagging way behind the Conservative Party in opinion polls. Many voters have tied their shifting support to cost-of-living pressures, including the rapid run-up in housing costs.
To tame inflation, the Bank of Canada raised interest rates aggressively over 2022 and 2023. Higher lending rates have tempered demand in the economy, helping to curb price pressures, but have also inflicted damage to the labour market, where unemployment is rising.
Even so, the inflation fight appears to be nearing an end. And because of the progress to date, the Bank of Canada has started cutting interest rates, offering some relief to consumers and businesses.
“There’s still a bit of work to do, but there’s no question today was welcome news,” Ms. Rogers said.
Tuesday’s CPI report showed a cooling of inflationary pressures on several fronts.
Prices for clothing and footwear dropped 0.6 per cent in August from July as retailers offered discounts to weary consumers during the back-to-school season. Gasoline prices fell 5.1 per cent on a monthly basis in August.
Housing costs remain a major financial pressure, although there is some improvement in that area. Shelter costs rose at an annual rate of 5.3 per cent in August, down from 5.7 per cent in July.
Another sign of progress is core inflation, which strips out volatile movements in the CPI. The BoC’s preferred measures of core inflation rose by an annual average of 2.4 per cent in August, down from 2.6 per cent in July.
The headline inflation rate of 2 per cent was the lowest since February, 2021. Analysts are expecting another soft reading in September, because gas prices have continued to fall.
Former Bank of Canada deputy governor Paul Beaudry, who left the bank last summer, said the latest inflation numbers “open the door” to the possibility of half-point interest rate cuts.
“There should be room to really decrease now, and kind of bring things down quickly,” he said in an interview.
“There’s no reason to wait to accelerate the pace of rate cuts,” said Royce Mendes, head of macro strategy at Desjardins Securities.
Financial markets are pricing in a roughly 50-50 chance that the BoC cuts its benchmark interest rate by a half-point at its next meeting on Oct. 23, according to Bloomberg data. The central bank has made three consecutive quarter-point cuts since June, taking the policy rate to 4.25 per cent from 5 per cent.
BoC officials have noted that inflation could bump up in the coming months, and according to their July projections, they don’t expect a sustainable return to the 2-per-cent target until well into 2025. The bank’s economic projections will be updated at the October rate announcement.
The U.S. Federal Reserve is universally expected to begin cutting rates on Wednesday. The bigger question is whether it will deliver a quarter-point or half-point cut, an outcome that investors are split over.
Bank of Canada Governor Tiff Macklem has said larger reductions are possible here if economic conditions are much weaker than anticipated. “If we need to take a bigger step, we’re prepared to take a bigger step,” he said earlier this month.
Former deputy governor Tim Lane, who left the bank in the fall of 2022, said it’s too early to declare “mission accomplished.” But he said the bank’s actions forestalled the kind of inflationary spiral seen in the 1970s and that he felt “vindicated.”
“There’s a pretty widespread view now that we could have started moving more quickly” with interest rate hikes, Mr. Lane said in an interview. “But when we did move, we moved pretty decisively and we gave clear signals of what we were doing.”
Mr. Beaudry said the return to 2 per cent should help shore up the central bank’s credibility in the eyes of Canadians. Runaway inflation pushed the bank to the centre of public discourse and opened it up to attacks from across the political spectrum, most notably from Conservative Party Leader Pierre Poilievre who promised during his 2022 leadership campaign to fire Mr. Macklem.
“In terms of the credibility of the central bank, I think it is huge,” Mr. Beaudry said. “You got a real challenge thrown at it, with lots of supply shocks, lots of different things.”
After an inflation shock, the goal for central bankers is getting CPI growth back to 2 per cent in a reasonable timeframe – preferably without causing a recession. There will be discussion over whether the BoC accomplished this quickly enough, Mr. Beaudry said. “But I think this is as quick as you could get it, more or less, without having even a higher cost” to the economy.