Inflation continued to trend downward in February, raising the odds that the Bank of Canada will once again leave interest rates untouched at its April meeting.

The country’s Consumer Price Index headline measure of inflation slowed to 5.2% in February, which was down from 5.9% in January. That’s the slowest pace of annual growth since January 2022 and the largest deceleration in three years.

The slowdown in inflation was due in part to base effects (i.e. a lower inflation reading a year ago), as well as declines in energy prices, namely gasoline (-4.7%). On the other hand, grocery prices (+10.6%) and mortgage interest costs (+23.9%) continued to provide upward pressure.

The Bank of Canada’s preferred measures of core inflation, the three-month annualized rates for CPI-trim and CPI-median, are at 3.3% and 3.8%. While still above the Bank’s target range, they’re also at the weakest readings in 16 months.

“With inflation subsiding on both the headline and core measures, the Bank of Canada is in a less awkward position than many others during the recent financial turmoil,” noted BMO’s Douglas Porter. “There's really no underlying reason for the Bank to hike further, especially with the Canadian dollar finding a footing.”

The Bank of Canada has been clear that the current pause in its current rate-hike cycle remains conditional while the Bank’s Governing Council monitors economic data and assesses if monetary policy is “sufficiently restrictive.”

In a summary of the council’s deliberations at its previous rate meeting, members said they “remain prepared to increase the policy rate further if needed to return the inflation rate to the 2% target.”

But for now, at least, it looks like that’s not going to be necessary, particularly with the heightened market volatility and ongoing bank liquidity concerns in the U.S. and Europe.

As a result, markets have moved up expectations for the Bank of Canada’s first rate cuts, with two quarter-point cuts now priced in before the end of 2023.

“With global banking woes adding to downside growth risks and the upcoming budget expected to exercise fiscal restraint, the next move in rates should be downward, with a rate cut possible before the end of the year,” wrote James Knightley, ING’s Chief International Economist.

“Canada’s greater exposure to interest rates rate hikes via a high prevalence of variable rate borrowing means consumer activity should slow through 2023.”

Too soon to celebrate?

While the decline in the headline inflation reading is good news, some economists say it’s still too soon for the Bank of Canada to declare victory in its battle against high inflation.

“The good news is that inflation continues to decelerate. The bad news is it’s the result of lower commodity prices, as core CPI remained sticky in February by several measures,” wrote Randall Bartlett, Senior Director of Canadian Economics at Desjardins. 

He said this could put the Bank in a “tough spot” since the labour market remains tight and given the re-acceleration in wage growth.

“However, deteriorating financial market conditions on the back of a series of banking system issues in the U.S. and Europe suggest risks to financial stability are a material concern,” he added. “This reinforces the Bank’s current holding pattern.”