All about that base effect

Canada's headline CPI rose 0.5 percent (not seasonally adjusted) in January, after declining 0.6 percent in December. Despite the sharp month-to-month reversal, the decline in year-on-year CPI growth continued, with the headline index rising 5.9 percent in January from a year earlier, down from the 6.3 percent increase posted in December. This reflects a very strong "base effect" on the year-on-year calculation, as the outsized monthly increases posted in early 2022 start to fall out of the calculation. The data release from StatsCan actually includes a technical note on the base effect, something that might usefully have been provided sooner.  

Behind the headline number, there are still some concerning elements to today's report. Food prices continue to rise at a double-digit pace, with a 1.7 percent rise in January alone bringing the year-on-year increase to 10.4 percent. Gasoline prices, which have been generally well-behaved in recent months, jumped 4.7 percent in January, mainly as a result of refinery disruptions in the United States.  While overall shelter costs were largely flat in January, the mortgage interest cost index jumped to 21.2 percent year-on-year, the fastest rise in almost forty years. This is, of course, a direct result of the Bank of Canada's inflation-fighting interest rate hikes. 

Measures of core inflation continue to move lower in line with the headline figure. CPI excluding food and energy rose 4.9 percent year-on-year, while CPI excluding mortgage interest rose 5.4 percent. Two of the Bank of Canada's three preferred measures of core inflation eased in the month, but their mean value of just below 5.4 percent is still well above the 2 percent target.

Looking ahead at the February data, it is already evident that the run-up in gasoline prices has fully reversed, which will bias the headline number lower. On the other hand, food price gains are likely to remain robust, not least because one of the largest grocery store chains just ended its voluntary freeze on the prices of own-brand products.  That being said, for February and the next several months, the key to predicting the path of headline CPI will be the base effect. Barring some entirely unforecastable event, the steady removal of last year's bloated figures from the calculation will push the year-on-year number significantly lower until at least mid-year, allowing the Bank of Canada to remain safely on the sidelines.