Inflation surges past five per cent, adding pressure on the Bank of Canada to raise interest rates

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Canada’s main inflation gauge is now glowing an even brighter shade of red, guaranteeing that interest rates will rise in a couple of weeks, and raising the possibility the Bank of Canada will have to accelerate its plans to cool the economy.

The consumer price index (CPI) increased 5.1 per cent in January from a year earlier, marking the first time the index has exceeded five per cent since September 1991, Statistics Canada reported on Feb. 16.

Inflation at that pace ends whatever doubt remains about whether the Bank of Canada will raise the benchmark interest rate from its emergency setting of 0.25 per cent next month. It also stoked a debate over whether governor Tiff Macklem and his deputies might opt to lift borrowing costs by half a point at the end of their next round of deliberations on March 2, instead of the customary quarter-point change that most on Bay Street expect.

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“The economy could handle a (half-point) hike,” said Philip Petursson, chief investment strategist at IG Wealth Management. “The central banks are behind the curve. Inflation is going to be difficult to stop.”

Macklem, who opted against raising the benchmark rate last month, has repeatedly said since December that he’s “uncomfortable” with year-over-year increases in the CPI that have surged well past the central bank’s target of two per cent.

The Bank of Canada won’t be surprised by the headline number, which matches its forecast for first-quarter inflation. But it will harden policy-makers’ resolve to put price pressures ahead of economic growth for the rest of the year, if not longer.

“This surge in inflation has been more persistent than anticipated,” Timothy Lane, a Bank of Canada deputy governor, said in a speech on Feb. 16, after the new CPI reading was released.

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“While we now expect supply disruptions to ease and inflation to come down quickly in the second half of the year, we are alert to the risk that inflation may again prove more persistent,” he added. “We will be nimble — and if necessary, forceful — in using our monetary policy tools to address whatever situation arises, as we have done throughout these turbulent times.”

Macklem, Lane and their colleagues on Governing Council were ready for CPI increases of five per cent, but they still won’t like some of the details in Statistics Canada’s latest price checks on the hundreds of goods and services it monitors to get a monthly reading of overall cost pressures.

Earlier in the pandemic, inflation could be explained away as a commodity story, since energy prices were having an outsized influence on the broader index. That’s no longer the case. Excluding gasoline, the CPI increased 4.3 per cent from January 2021, the biggest gain since Statistics Canada introduced the measure in 1999 to get a cleaner read on underlying cost pressures because oil prices are so volatile.

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That suggests inflationary pressures that began with commodity prices are now spreading throughout the economy. All the groups Statistics Canada uses to arrange the items in its price basket posted significant gains. The agency’s measure of shelter costs increased 6.2 per cent from January 2021, the fastest since February 1990.

Benoit Durocher, an economist at Desjardins Group, noted that the cost of a “whopping” 68.8 per cent of the items in the price basket increased more than three per cent, the outer limit of the Bank of Canada’s comfort zone.

“Based on our projections, annual inflation could continue to rise in the coming months before starting to gradually fall this spring,” he said in a note. “That leaves little doubt that the (Bank of Canada) will start hiking interest rates at its March 2 meeting.”

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Real-estate prices aren’t included in the CPI, because Statistics Canada classifies homes as assets. However, housing prices influence other costs related to owning or renting a dwelling, including estimates of how much it would cost homeowners to replace their current living arrangements. Replacement costs surged 13.5 per cent from a year earlier, outweighing the disinflationary effect of lower mortgage costs, which were 6.8 per cent lower.

Food prices at grocery stores rose 6.5 per cent year over year, compared to 5.7 per cent in December, as supplies, affected by tough growing conditions around the world, continued to fall well short of demand. Higher shipping costs from various supply chain disruptions are also putting upward pressure on food prices, Statistics Canada said.

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Gasoline remained a key driver of overall inflation. Prices increased more than 30 per cent from January 2021 as oil prices jumped amid worries Russia was on the verge of invading Ukraine, aggravating the most intense period of geopolitics since the end of the Cold War.

There is no doubt interest rates are heading higher, but there is no consensus on how high they might go, or how fast the central bank might try to get to its destination.

Petursson described the current situation as the “new post-COVID reality,” adding it was “really reaching” to think things would be back to normal by 2023.

Macklem’s predecessor has an entirely different take. Stephen Poloz this week said the original thesis — prices were rising mostly because of a series of idiosyncratic supply issues — remained the best explanation, and, therefore, inflation should naturally cool as those issues get sorted.

“I’m not saying it isn’t an issue,” Poloz said at an event hosted by Rosenberg Research & Associates Inc. “It’s just overcooked.