The latest data released by Statistics Canada shows that the Consumer Price Index (CPI) rose 3.1% year-on-year and 0.1% month-on-month in September, with overall inflation once again reaching the upper limit of the Bank of Canada's 1% to 3% target range. Although some indicators of core inflation have slowed, the smoothed trend still shows that price pressures have not completely subsided. Derek Holt, Vice President of Economic Research at Scotiabank, pointed out that Bank of Canada Governor Tiff Macklem has clearly shifted his focus to forward-looking inflation risks, downplaying the importance of lagged monthly data, and market pricing indicates that the probability of an interest rate hike at next week's policy meeting has increased significantly.

Overall inflation has rebounded to the upper end of the target range, with energy prices being the main driver.

Canada's overall CPI rose 3.1% year-on-year in September, a slight acceleration from 3.0% in August, and increased 0.1% month-on-month on an unadjusted basis. This result was slightly below the market consensus of 3.2%, but remained at the upper end of the central bank's target range. Energy prices were a key factor driving the overall reading higher, with gasoline prices rising 27.8% year-on-year, significantly higher than August's 22.8%. Food prices continued to slow, with store purchases of food rising only 1.7% year-on-year, the slowest pace since May 2024. The core CPI, excluding food and energy, remained at 2.1% year-on-year, with a seasonally adjusted annualized month-on-month increase of only 1.5%, the weakest reading since April. However, this slowdown was largely driven by a sharp decline in travel service prices. Overall travel service prices fell 25% month-on-month on an unadjusted annualized basis in September, while car rental prices fell even more sharply by 38%. Even after removing these seasonal factors, core price pressures still showed signs of broader transmission.

The trend of core inflation smoothing remains positive, but upside risks have not disappeared.

The Bank of Canada's key core inflation indicators, the cut-off mean and weighted median, both recorded a seasonally adjusted annualized rate of 2.2% month-over-month in September. The weighted median figure for August was revised upward by more than 0.5 percentage points, with the three-month moving average rising to 2.7%; the cut-off mean's three-month moving average was 2.6%. Year-over-year, the cut-off mean fell to 1.8%, and the weighted median was 1.9%. While there was a decline, Holt emphasized that these year-over-year indicators reacted too slowly at the inflation inflection point, and the smoothing trend month-over-month better reflects the true pressure. In terms of breadth, nearly 60% of the CPI basket components saw year-over-year increases of 2% or more. Core goods inflation rebounded somewhat, and while services inflation slowed due to the drag from travel-related items, the trend remained bullish after excluding travel services. Bank of Canada staff have repeatedly underestimated risks at inflation inflection points in the past. Currently, the policy rate is still at the lower end of the neutral range, and the real interest rate is negative, further exacerbating the risk of policy lag.

Macklem shifts to forward guidance, solidifying market pricing of interest rate hikes.

Macklem's recent statements have clearly downplayed lagging data, instead emphasizing higher forward-looking inflation forecasts and upside risks. He pointed out that the newly released forecasts will show higher inflation in Canada. The market reacted accordingly, pricing in a rate hike of around 18 basis points at the policy meeting on October 28th next week, with the yield on Canadian two-year government bonds performing at the bottom among major economies' forward-looking interest rates. Holt believes that although single-month data is not a decisive factor, the trend has provided sufficient support for a rate hike. If a significantly priced-in rate hike ultimately fails to materialize, it could instead bring greater risks through easing financial conditions. Current policy needs to hedge against potential upward pressure on commodity prices, possible fiscal expansion, and geopolitical uncertainties, especially given the long time lag in policy transmission. Waiting longer could cause the central bank to further lag behind the evolution of inflation risks.

Editor's Summary

Canada's overall inflation rose to 3.1% in September, primarily driven by energy prices. While core indicators showed some slowdown, the smoothed month-on-month trend still indicates persistent price pressures. The central bank governor has clearly shifted the focus to forward-looking risks, and the market's pricing in a rate hike next week is relatively stable. The environment of policy rates at the lower end of the neutral range and negative real interest rates, coupled with potential commodity and fiscal pressures, has fueled discussions about an "insurance" rate hike. Going forward, close attention needs to be paid to whether the breadth of core inflation expands, changes in inflation expectations, and the further impact of geopolitics on energy prices. These factors will determine whether monetary policy will shift towards tightening ahead of schedule.