Canada’s Inflation Rate Hits 2% Target, Easing Pressure on Interest Rates

Inflation in Canada reached the Bank of Canada’s target of 2% in August, the lowest level since February 2021, marking a significant shift after a prolonged period of rising prices. This decline from 2.5% in July can be attributed to falling gasoline prices and reduced costs for clothing and footwear, which saw their first month-over-month drop in August since 1971.
Economists suggest this slowdown indicates inflation is no longer a major threat, potentially allowing the Bank of Canada to focus on stimulating the economy. CIBC senior economist Andrew Grantham expressed concern that the economy may be weaker than necessary to sustain inflation at the target level, noting that excluding mortgage interest costs, the annual inflation rate was just 1.2% last month.
The unexpectedly sharp decline in inflation could lead to increased calls for larger interest rate cuts ahead of the Bank’s upcoming October meeting. Benjamin Reitzes from BMO stated that if another significant decline is reported, demands for a 50 basis-point cut could intensify.
Bank Governor Tiff Macklem has indicated readiness to accelerate rate cuts if inflation or economic performance worsens. The Canadian economy has been under strain from high interest rates, with the unemployment rate climbing to 6.6% in August.
As inflation approaches the target, the Bank’s challenge will be to maintain it without allowing it to drop too low. The central bank, which began aggressively raising rates in March 2022 in response to soaring inflation that peaked at 8.1%, currently has its key rate at 4.25%. CIBC forecasts that the Bank will implement two half-percentage-point cuts by mid-2024.
As the Bank of Canada navigates this complex economic landscape, all eyes are also on the U.S. Federal Reserve, which is expected to announce its first interest rate cut in four years soon.