Canada inflation: a one-time blip

Well, that was certainly unexpected.  Statistics Canada reported this morning that headline CPI rose 2.1 percent year-on-year in January, up from 1.5 percent in December and way above the analysts' consensus for a 1.6 percent annual gain.  This marks the first time the headline index has topped the Bank of Canada's 2 percent target since October 2014.

As seems to happen far too often, the consensus seems to have failed entirely to notice what was actually happening during the month in question.  Both Ontario and Alberta instituted new carbon pricing measures at the start of the year -- a levy in Alberta and a cap-and-trade scheme in Ontario.  Largely because of this, gasoline prices shot up 20 percent year-on-year, accounting for most of the monthly increase in the headline index.  If gasoline is excluded, the year-on-year rise in CPI merely ticked up to 1.5 percent in January from 1.4 percent in December.

Alberta and Ontario's energy levies aren't going to fall out of the index any time soon, but there are still reasons to think that headline CPI will come in lower in February.  The increase in pump prices on the first of the year here in Ontario was wildly disproportionate to the true impact of cap-and-trade -- can you spell "gouging", children? -- and prices have now settled back to levels very close to where they stood at the end of 2016.  So the January data almost certainly do not have any immediate implications for Bank of Canada policy.

The Bank will take further comfort from the performance of the three clumsily-named measures of underlying inflation it unveiled during 2016.  All three of these are below the 2 percent target, with only one of the three (CPI-median) looking even remotely threatening, at 1.9 percent year-on-year in January.  If the Bank really intends to rely primarily on these measures, any increase in its policy interest rate is still many months away.  This implies that the market action after today's release, which saw investors pricing in a slightly higher chance of a rate hike during 2017, will almost certainly be unwound.  

Even so, the Bank's job may become a little trickier in this first year of the Trump era.  The new President has already signalled his desire to renegotiate the NAFTA agreement (though his main target is, for the moment, Mexico) and regularly rails about currency manipulation (though his main target is, for the moment, China).  As and when the Federal Reserve further tightens its policy settings, the Canadian dollar can be expected to weaken as the Bank of Canada declines to follow suit.

Further exchange rate weakness will assuredly lead Washington at a minimum to take a harder line at the negotiating table, and at worst even start to levy accusations of manipulation.  Canadian policymakers seem to be trying their hardest to stay out of Trump's line of sight; it won't be possible to do that forever.