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Canadian Inflation Surprised to the Upside in December (Airfares Again!)

Highlights:

  • Headline CPI inflation unexpectedly jumped to 2.0% in December from 1.7% in November.
  • Airfares rose 22% month-over-month with methodology changes to that component causing volatility over the second half of 2018. July’s 16% increase was subsequently retraced in September, and we expect this latest jump will also be walked back in the coming months.
  • The BoC’s three preferred core measures averaged 1.9%, unchanged from November. Ex food and energy inflation rose to 2.3% year-over-year, but with airfares playing a major role in the increase.

Our Take:

Canadian inflation unexpectedly rebounded to 2.0% in December. Expectations were for the headline rate to hold steady at 1.7%, but a significant jump in airfares (methodology changes have made this component extremely volatile over the last six months) added a surprising 0.3 percentage points. In July when we saw a similar airfare-driven jump in inflation, the Bank of Canada looked through the increase and we expect they’ll do so again this time. Outside of airfares, today’s inflation report was largely as expected with a sizeable drop in energy prices and the usual seasonal declines in clothing & footwear, home entertainment, and travel services. Energy prices were a major factor in inflation spending much of 2018 above the BoC’s 2% target. But that dynamic has been flipped on its head thanks to a sharp decline in oil prices toward the end of last year. We expect inflation will be held below 2% for the better part of 2019 as oil prices aren’t likely to climb back to the $70/bbl range seen in May through October 2018.

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While headline inflation is being whipsawed by energy prices and airfares, core inflation remains relatively steady at (or a shade below) 2%. The BoC sees that as evidence the economy has been operating close to full capacity for more than a year now. A slowdown in the energy sector is likely to leave oil-producing provinces with a bit of slack, but we think tighter conditions in the rest of Canada will keep underlying inflation close to target. At the same time, we’ve seen few signs of price pressures building. This inflation sweet-spot gives the BoC time to be patient in raising interest rates. We think they’ll want to see how the economy is progressing through this latest oil price decline, and expect the current pause in their tightening cycle will extend through their next meeting in March.

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