Canada's Inflation Rises to 1.9% as Higher Energy Costs Offset GST Relief

Last month, Canada's annual inflation rate rose slightly. Still, it stayed below the Bank of Canada's target, as increasing energy prices offset the residual advantages of the federal tax break on food and other items.

Statistics Canada reported on Tuesday that the Consumer Price Index increased by 1.9% year on year in January, up from 1.8% in December. It was the first uptick in inflation in three months, and it met analysts' predictions.

Following the inflation report, financial markets reduced their expectations for another interest rate cut from the Bank of Canada. According to LSEG statistics, the probability of another quarter-point decrease at the central bank's next meeting on March 12 has dropped from over 40% prior to the Statscan report to around 30%.

The central bank's two preferred core inflation measures, which exclude volatile price movements, increased to an average of 2.7%, up from 2.55% in December. That shows pricing pressures are rising beneath the headline CPI figure, which has been weighted down by the two-month GST/HST break that began in mid-December and concluded on February 15.

The Bank of Canada has cut interest rates six times in a row, lowering its benchmark rate to 3% in January. However, the future course of monetary policy remains uncertain.

With inflation below the central bank's 2-percent target and the policy rate approaching the bank's estimate of "neutral," policymakers have stated that additional rate cuts are not guaranteed. At the same time, if a full-fledged trade war with the United States breaks out, the central bank may be forced to cut substantially to help the Canadian economy weather a recession.

"The GST holiday meant that headline inflation remained below the 2 percent target in January, but there is clear evidence that underlying inflation pressures are building," noted Stephen Brown, deputy chief North America economist at Capital Economics, in a note to clients. "That suggests the Bank of Canada is getting close to the end of its loosening cycle, although the outlook for monetary policy ultimately hinges on whether President [Donald] Trump soon imposes stiff tariffs on imports from Canada."

Statscan calculates the Consumer Price Index by examining the prices of products and services, including taxes. That indicates that tax changes affect CPI inflation.

The Liberals' two-month tax break, introduced late last year in an effort to boost their political fortunes, has continued to have an impact on food price inflation. Food prices fell 0.6 percent year on year, the first annual reduction since May 2017. This was fueled by a 5.1 percent drop in restaurant pricing, which was three times the previous record drop.

As a result of the tax reduction, Canadians spent 3.6% less on alcoholic beverages and 6.8% less on toys, games, and hobby supplies year after year.

This was offset by a rise in fuel prices, which were up 8.6 percent year on year in January after rising 3.5 percent in December. In Manitoba, gasoline prices increased 26% after the provincial sales tax was reinstated following a year-long respite in 2024.

Natural gas prices increased 4.8 percent on an annual basis, following a 5.5 percent drop in December.

Housing remains the most significant driver of overall inflation, albeit rises in home ownership and rental expenses are moderating. Mortgage interest rates rose 10.2% year on year in January, compared to 11.7% in December, while rents rose 6.3% year on year, compared to 7.1% the previous month.

"No big surprises in today's report, which is generally a good thing on the inflation front, and we'll call this one a draw on the interest rate outlook front," said Bank of Montreal chief economist Douglas Porter in a note to clients.

However, as the GST vacation ends in the following two months, the headline tally is expected to rise soon to meet current core trends of around 2.5 percent. We continue to lean toward the idea that the BoC will take a pause at its next meeting (March 12). However, developments on the tariff front may still have a significant say in that determination - the projected 25% U.S. tariff on Canada and Mexico still looms on March 4.