Canada: Inflation Jumps as the GST/HST Holiday Comes to an End, But the BoC’s Troubles are Just Getting Started

With the two-month GST/HST holiday having come to an end on February 15, it didn’t come as a surprise that inflation perked up above the Bank of Canada’s 2% target in February. But few economists saw inflation hitting 2.6% y/y in the month. The rebound was most notable in food inflation, which rose by 1.3% after dropping 0.6% in January (graph 1), as the cost of food purchased at restaurants declined at a slower pace (-1.4% in February versus -5.1% to start the year). However, CPI inflation excluding food accelerated again, hitting 2.9% in February, up from 2.4% a month earlier. That can be partly chalked up to the GST/HST being reapplied to various goods partway through the month, such as alcoholic beverages. That said, our estimate suggests that total CPI inflation would have come in at closer to 3% in February if not for the federal tax measure. At the same time, the inflationary tailwind from energy slowed to 3.0% from 5.3% in January, thanks to a more modest month-over-month gain of 0.6% m/m in the price of gasoline in February.

While the end of the sales tax holiday helped to push the price of goods higher in February (1.5% y/y), services price growth also accelerated in the month (to 3.6% from 2.8% in January). An 18.8% increase in prices of travel tours was partly to blame. That said, while shelter inflation continues to make the largest contribution to headline inflation, it maintained its trend deceleration, hitting the slowest pace of advance since May 2021. Instead, the contribution from core non-shelter CPI to year-over-year total CPI inflation nearly tripled in the February from a month earlier, contributing almost as much as core shelter inflation for the first time in almost two years (graph 2).

Looking to underlying inflation, the Bank of Canada’s preferred measures of core year-over-year price growth—CPI median and trimmed mean—accelerating by two ticks in February (averaging 2.9% y/y). The annualized 3‑month moving average of these seasonally adjusted series edged higher in February to an average of 3.3%, remaining at or above 3% for the fifth consecutive month. But more concerning are the traditional measures of underlying inflation. For instance, the seasonally adjusted 3‑month moving average of the more commonly used total CPI excluding food and energy soared to 4.5% from 2.7% in January (graph 3). Meanwhile, the Bank of Canada’s previously preferred measure of underlying inflation—total CPI excluding the eight most volatile components and indirect taxes—jumped from 3.4% to 4.7% when measured similarly. All told, underlying inflation showed signs of heating up in February, no matter how you slice it.

With the drag from the GST/HST holiday starting to come out of CPI numbers in February, inflation is likely to track higher again in March when it is entirely in the rearview mirror. Indeed, both the Bank of Canada and Desjardins Economic Studies External link. are projecting inflation of 2.5% y/y or higher in the month. When combined with the recent increase in consumer inflation expectations, we think this is likely to convince the Bank to pause its rate cutting cycle in April, at least temporarily.

However, the Bank of Canada will have a lot more to contend with on the inflation front as the year continues. For starters, the impact of counter tariffs and the weaker Canadian dollar should apply consistent upward pressure to inflation even as the economy slows External link.. But this will now be offset by lower energy prices starting in April 2025 as a result of the elimination of the federal price on pollution. The Bank of Canada has estimated that could reduce inflation by 0.7 percentage points immediately, and keep inflation similarly lower than it otherwise would be for the subsequent year (look for our analysis tomorrow detailing the impact). This will not only bring down actual inflation but, given the highly visible nature of gasoline prices, may help to keep a lid on consumer inflation expectations as well. As such, we’re not convinced that the Bank of Canada is done cutting rates just yet.