Canada’s Bank of Canada core Consumer Price Index (CPI) rose 2.6% year on year in January. This was down from 2.8% in the previous reading.
The 0.2 percentage point drop indicates slower core price growth compared with the prior period. The data focuses on core inflation, which strips out some volatile items.
Core Inflation Signals Earlier Rate Cuts
This morning’s drop in core inflation to 2.6% is a significant signal for us. It confirms that the restrictive policy from the Bank of Canada throughout 2025 is having its intended effect, perhaps more quickly than many expected. This number moves the timeline for a potential interest rate cut forward significantly.
Given this data, we should anticipate a dovish shift from the Bank of Canada at its next meeting. The market, as seen in CORRA futures, is now pricing in over a 70% chance of a 25 basis point cut by the April meeting, a jump from just 40% last week. We should be positioning in derivatives that benefit from falling short-term rates, such as buying call options on three-month CORRA futures.
The Canadian dollar will likely weaken as rate cut expectations solidify, widening the policy divergence with the U.S. Federal Reserve, which is dealing with slightly more persistent inflation. We should consider buying USD/CAD call options with expirations in the next two to three months to capitalize on this trend. This view is reinforced by the soft Q4 2025 GDP figures that showed the Canadian economy stalling.
We saw a similar dynamic in the second half of 2025 when employment numbers began to soften after a long period of strength. That was the first major crack that led the BoC to pause its hiking cycle. This sharp drop in core CPI feels like the second, more important crack that signals an actual policy pivot is coming soon.
Volatility May Fade As Market Reprices
The immediate reaction will cause a spike in implied volatility, but the path forward for the BoC is now clearer. In the coming weeks, we could see a decline in volatility as the market coalesces around a spring rate cut. This might present an opportunity to sell volatility on longer-dated Canadian interest rate options, betting that the new dovish direction is now firmly established.
