Trajectory could set the course for future interest rate cuts
Economists expect this week’s data to confirm that inflation cooled in December, setting the stage for the Bank of Canada to continue its cycle of interest rate cuts, according to reporting by The Canadian Press.
A poll conducted by Reuters suggests that December’s annual inflation rate likely dropped to an average of 1.7%, down slightly from November’s 1.9%. RBC, however, projects an even sharper decline to 1.5%, crediting the federal government’s temporary GST holiday for reducing consumer spending on items such as food, alcohol, restaurant meals, and toys.
“We still have this view that the broader macroeconomic backdrop and current consumer demand is just pretty weak,” noted Claire Fan, an economist at RBC.
In a Friday note, RBC economists Nathan Janzen and Abbey Xu explained that slowing food price growth should offset increases in energy prices. “The final consumer price index report for 2024 on Tuesday will be closely watched for further signs of easing in underlying price pressures in Canada, but we expect the data will be distorted by the GST holiday that began on Dec. 14,” they wrote.
Other forecasts vary slightly. BMO expects inflation to come in at 1.8%, slightly above consensus, citing uncertainty surrounding the timing of the GST tax change. “There’s a bit more uncertainty than usual ... as the tax change took effect mid-month, so it should take two months to see the full impact, but it’s possible most of it comes up front,” said Doug Porter, BMO’s chief economist.
Porter added that easing shelter costs, which have been a major driver of inflation, are expected to further relieve inflationary pressure. “Shelter cost momentum looks to continue ebbing, with slowing gains in mortgage interest costs. We’ll also be watching for any signs that the recent depreciation in the Canadian dollar is having an impact, with a particular eye on fresh food.”
In contrast, TD anticipates headline inflation will remain at 2.0%, driven by higher energy prices and slight upticks in food and shelter costs, according to senior economist James Orlando. TD also forecasts the Bank of Canada’s preferred core inflation measures—which strip out volatile components—will stay steady at 2.6%.
Underlying Inflationary Trends
Even with the temporary effects of the GST holiday, economists agree the overall trend shows inflation steadily declining. “The overall backdrop ... it’s pretty soft, it has been softening for quite a bit already,” said Fan. “That’s really going to show up, continue to show up in inflation data regardless of some of the near-term fluctuation or disruptions caused by the tax changes.”
Fan also pointed out that holiday spending saw a boost due to the GST holiday, which may lead to positive signs of easing inflation pressures in the December report.
Interest Rate Cuts on the Horizon
The Bank of Canada has been aggressively lowering its policy rate to support the economy, with its most recent cut bringing the benchmark rate to 3.25%. Economists widely expect the central bank to continue cutting rates in the coming months, as inflation stabilizes around its 2% target.
Fan anticipates that the central bank, which is now more focused on economic growth than inflation, will implement a series of smaller rate cuts throughout 2025. “We expect the central bank to cut five times in a row this year, beginning later this month, until its key rate sits at two per cent,” she said.
However, external factors such as potential U.S. tariffs could complicate this outlook. Tariffs are typically inflationary for the U.S., and experts caution they could also drive up prices in Canada.
In a December note, TD senior economist Leslie Preston predicted inflation could rise modestly above the Bank of Canada’s 2% target in 2025 due to the ripple effects of tariffs. However, she added, the increase is unlikely to deter the central bank from continuing to cut rates.
BMO’s Porter echoed this sentiment, emphasizing that the Bank of Canada is likely to prioritize economic growth over inflation concerns. “While the debate in the U.S. is all about how much inflation tariffs may cause, the only question in Canada is how much growth damage they will inflict,” he said. “We continue to believe that the correct response by the bank to U.S. tariffs would be to cut early, and cut often.”
As the inflation report nears, economists will be watching closely to see how key indicators align with these forecasts and what the implications may be for Canada’s monetary policy trajectory.
