Canada’s CPI slowed in January, with headline inflation at 2.3%. Measures excluding indirect taxes came in at 2.1%, down from 2.5% in December.
The Bank of Canada’s core trim and core median measures eased to an average of 2.5% year on year. This was down from 2.6% in December, after a 0.1% month-on-month rise.
Core Inflation Trends
Core trim and core median were at 2.4% and 2.5%, above the Bank’s 2% target. Over the past three months, they averaged a 1.2% annualised rate.
The share of the CPI basket with unusually fast price rises also fell. About 23% of the basket rose at above a 5% rate over the last three months, down from 28% in December and 30% in November.
The data left policymakers with more room to cut interest rates if economic conditions weaken. The base case referenced in the source did not assume further rate cuts, while grocery and services prices remained elevated.
From our perspective in mid-February 2025, the latest inflation data for January is a significant development. With headline inflation slowing to 2.3%, the Bank of Canada now has more flexibility to cut interest rates if the economy continues to show signs of weakness. This reinforces the view that the next policy move will be an easing one.
Market Implications For Rates
The Bank’s preferred core measures have also dipped to 2.5%, with the annualized rate over the last three months at a very low 1.2%. Considering the policy rate has been held at 4.25% since December 2024, markets will now price in a higher probability of a rate cut in the upcoming spring meetings. This outlook should support strategies that benefit from falling interest rates, such as buying call options on Government of Canada bond futures.
This dovish tilt is likely to put downward pressure on the Canadian dollar, particularly against the U.S. dollar, as the Federal Reserve has maintained a more cautious stance on its own timeline for rate cuts. The growing policy divergence suggests that derivative plays betting on a weaker loonie, such as buying puts on CAD futures, could be profitable. This is a key theme we have been watching since the beginning of the year.
This inflation report comes after Canada’s GDP growth nearly stalled in the fourth quarter of 2024 and the national unemployment rate edged up to 5.8% in January 2025. The prospect of earlier-than-expected rate cuts to bolster this sluggish economy could provide a tailwind for Canadian equities. We could see increased buying of call options on the S&P/TSX 60 index as traders anticipate a more supportive monetary environment.
Finally, the disinflation trend is becoming more widespread, not just concentrated in a few items. We noted that the portion of the consumer price basket seeing high price growth fell to 23% in January, a steady decline from 30% back in November 2024. This consistency strengthens the case for the Bank of Canada to act, potentially leading to lower implied volatility in rate markets as the policy path becomes clearer.
