• While food and shelter provide some lift, falling transportation and energy costs lower headline inflation to 1.2%
  • With economic slack building up, core inflation dips below the Bank of Canada's 2% target

With commodity prices falling and Canada believed to have plunged into a recession, consumer prices continue to experience significant downward pressure. Headline inflation mellowed to 1.1% Y/Y in January from 1.2% Y/Y in December. Moreover, with the GST cut taking effect last January, the effect of this tax break fell out of the Y/Y reading. On a monthly basis, this was the fourth month of decline in the all-item Consumer Price Index (CPI). Core inflation, which excludes the eight most volatile components, also felt a strong downdraft, falling to 1.9% Y/Y from 2.4% Y/Y in December. The -0.3% M/M decline in the core measure is its largest monthly dip since April 2003. Furthermore, core inflation's three-month annualized trend fell precipitously to 1.8% from 2.9% in December. The core measure has now moved below the Bank of Canada's 2% target and Canada's mounting excess capacity will place additional downward pressure on inflation in the months to come.

Of the eight major components, only three posted monthly declines. However, the transportation index fell by 1.4% M/M, heightening its annual decline to 7.5% Y/Y. Representing 20% of the CPI basket, transportation is the largest component after shelter and easing pressure at the pumps has diminished these costs. As well, January saw a wave of price incentives on autos as manufacturers attempted to spur their flailing market. Shelter costs are still increasing 3.3% Y/Y, owing to ongoing increases in mortgage interest costs, related to momentum from the early-2008 run-up in home prices. Nonetheless, shelter costs have cooled on a monthly basis, and should further moderate with house prices slumping nation-wide and interest rates remaining low.

Provincially, the Maritimes actually experienced a contraction in headline prices during January, owing to their high reliance on fuel oil for heating and the price slump in that sub-component. However, on Atlantic shores, Newfoundland and Labrador nonetheless posted an increase, due partly to ongoing hikes in home ownership costs. Inflation abated to 1.4% Y/Y in Ontario and remained at 0.5% Y/Y in Quebec. While inflation in Saskatchewan continues to lead the nation at 2.4% Y/Y, Alberta is feeling the rapid slowdown with inflation cooling from 1.9% Y/Y in December to 1.2% Y/Y in January.

This decline in core inflation confirms our view for a final 50 basis point cut by the Bank of Canada on March 3rd, bringing the target overnight rate to 0.50%. Ahead, the output gap will increase as growth slumps well below potential, placing continued downward pressure on inflation. Continuing declines in house prices and falling durable good prices will register a strong downdraft. The Bank has good cause for a cut, but there remains limited room for further traditional monetary policy to move.

TD Bank Financial Group

The information contained in this report has been prepared for the information of our customers by TD Bank Financial Group. The information has been drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does TD Bank Financial Group assume any responsibility or liability.