Canada inflation unlikely to return to 2% target until 2024

TORONTO Reuters - Canadian inflation is not likely to return to the central bank's 2% target until 2024 after possibly peaking in June, as less volatile items like wages and rent displace energy as key sources of price pressure, analysts say.

Since March, the Bank of CanadaBank of Canada BoC has raised its benchmark interest rate by 225 basis points to 2.50%, including a full-percentage move in July, the biggest single hike by a G 7 country in the economic cycle.

If the economy goes into recession as some analysts expect, the central bank may be less willing to pivot to interest rate cuts next year because of a slow grind back to target.

The central bank would be cutting rates in March, and expectations were building earlier this month.

Even with the economy likely to see a mild recession next year, we think it will take until 2024 to get inflation back to normal, said Josh Nye, senior economist at Royal Bank of CanadaBank of Canada.

The Bank of Canada's latest forecast in July was for inflation to return to 2% by the end of 2024 and for the economy to avoid a recession.

Canadian inflation dropped to 7.6% in July due to lower gasoline prices, down from an almost 40-year high of 8.1% in June, but core price pressures that strip out the most volatile components, such as energy, continued to climb.

The problem is that increases in slower moving drivers of inflation, like wages and rent, are likely to be persistent or sticky, even as commodity-price gains and some supply constraints caused by the COVID 19 epidemic and the Ukraine war, analysts say.

Doug Jones, Chief Economist at BMO Capital Markets, said in a note that the biggest theme from the latest inflation reading is a significant rotation in which the most intense price pressures are coming from.

The Bank can scarcely back down anytime soon, as it has a long-term battle on its hands in reining in 5% core inflation. Money markets are now expecting the central bank's benchmark interest rate to peak at around 3.75% in the first quarter of next year and to stay close to that level through much of 2023, as the central bank's benchmark interest rate is expected to peak at around 3.75% in the first quarter of next year.

The Federal Reserve could have a long battle to bring inflation back to target. It has a dual mandate of employment and price stability, unlike the single goal of low inflation pursued by Canada's central bank.

Jimmy Jean, chief economist at Desjardins Group, said that the BoC is most likely biased towards overtightening rather than undertightening until they see evidence that demand is cooling.