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Bank of Canada's core inflation rate continues downward trek

Dawn Desjardins, Senior Economist, RBC ECONOMICS RESEARCH - DAILY ECONOMIC UPDATE
Published: Tuesday, February 19, 2008

The year-over-year all-items inflation rate slipped to 2.2% in January, lower than market forecasts for a 2.3% print. The Bank of Canada's core inflation rate, CPIX, fell to an as-expected 1.4%, the slowest pace since July 2005. The all-items index fell 0.2% in January over December, while the CPIX rose 0.1% on the month.

The 0.2% monthly decrease in the all-items CPI reflected a 0.5% dip in vehicle purchase and lease prices (due to manufacturer incentives and the 1% cut to the GST), a 10.3% drop in the price of travel tours and a 3.4% decline in men's clothing prices. Partially offsetting these declines were higher prices for gasoline, food, municipal water prices and rising mortgage interest costs.

Stats Canada reported that the 1% cut in the GST rate is estimated to have cut 0.6% off the level of inflation compared to what it otherwise would have been if the entire amount had been transferred to consumers in January. However, given that some businesses may have increased their margins during January and some had cut their prices in anticipation of the January tax reduction, the impact of the GST cut may have been less than anticipated.

On a year-over-year basis, higher gasoline prices supported the 2.2% increase in the all-items rate – they were 20.9% higher than in January 2007, a pick-up from December's 14.9% pace. Heating oil and other fuel prices were 24.7% higher than a year earlier. Higher mortgage interest costs, which rose at a 7.6% year-over-year pace, and a 4.5% increase in homeowners' replacement costs also supported the annual gain.

Costs for the purchase/lease of motor vehicles were 4.9% lower than a year earlier on the back of dealer incentives and the 1% cut in the GST. Prices for computers and women's clothing also posted big declines. Goods prices were 0.9% higher than in January 2007, while services prices were 3.3% higher than a year earlier, slower than December's 3.5% pace.

The core inflation rate continued its downward trek in January, moving further below the Bank's 2% target. The all-items inflation rate was lower than expected but remained above the 2% target, mainly reflecting energy price-related declines in the index last year facing off with the elevated energy prices in early 2008. The 1% cut to the GST rate on January 1 weighed against price increases for gasoline and housing-related costs, which resulted in a modest decrease in the year-over-year rate.

In his February 18 speech, Bank of Canada Governor Carney said that "In the pursuit of our 2 per cent target for total CPI, we use our core measure as an operational guide because it has been a good gauge of the underlying trend of inflation and has been a better predictor of future changes in the total index than has total CPI itself", keeping the focus on the core rate.

Expectations that the core inflation rate will remain low and that the trade sector will continue to constrain the pace of GDP growth in 2008 will keep the Bank in rate cut mode in the months ahead. In his speech Governor Carney commented that "the timing and degree of that stimulus will be determined at future fixed announcement dates, after we have conducted a thorough analysis of, and applied our judgment to, all information available to us at that time."

We expect that the overnight rate will be cut 50 basis points at the March 4 policy meeting with an additional 50 basis points in rate cuts to come at subsequent meetings to bring the rate to 3% by mid-year.

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