Inflation and the Consumer Price Index in Canada

Canadian CPI: October update

The latest Consumer Price Index (CPI) reading for September 2024 revealed that inflation slowed significantly to 1.6%, down from 2.0% in August. This marks the smallest year-over-year increase since February 2021 and is well below the Bank of Canada's 2% inflation target. The decline was primarily driven by a sharp drop in gas prices, which fell by -10.7%. On a monthly basis, CPI decreased by -0.4%.

Key measures of core inflation, closely monitored by the Bank of Canada, remained steady. CPI trim stayed at 2.4%, while CPI median held at 2.3%. One notable development is the ongoing reduction in mortgage interest costs. The largest component of the CPI basket, mortgage interest costs, saw growth slow to 16.7% in September, down from 18.8% in August. This marks the 13th consecutive month of decline, as recent Bank of Canada rate cuts continue to lower borrowing costs for mortgage holders.

Also read: Canadian CPI falls to 1.6% in September, increasing chance of half-point rate cut

Canada CPI release dates

Source: Statistics Canada

What is inflation?

Inflation refers to how prices rise or fall for common goods and services over time, and how that affects consumers’ purchasing power. This is measured using a “basket of goods and services”, and tracking how their prices change over the course of the year. Statistics Canada updates this basket annually, tweaking the weights of various components to accurately reflect consumer behaviour. This basket of goods is then used to set the Consumer Price Index, which provides a measurement for how inflation is rising or falling. This is also referred to as the “headline” inflation rate. Meanwhile, the “core” measures of inflation provide more nuanced looks into how prices are evolving, with the extremes stripped out.

When the headline inflation rate rises, this means the prices of consumer goods and services are also increasing, while a dropping inflation rate indicates deflation is occurring, meaning prices are falling, and consumers are seeing greater purchasing power.

What is the Consumer Price Index?

• The Consumer Price Index (CPI) is an index that tracks how much the average Canadian household spends on a variety of goods and services, and how that changes over time, which is referred to as price inflation.
• The Consumer Price Index is based on a 700-item basket of goods and services, divided into eight components: Food; Shelter; Household operations, furnishings and equipment; Clothing and footwear; Transportation; Health and personal care; Recreation, education and reading, and Alcoholic beverages, tobacco products and recreational cannabis.

Food inflation

Food inflation is one of the most closely-watched components of the CPI basket of goods, as consumers acutely feel the impact of higher food prices. Over the past three years, grocery costs have surged by 20.7%, adding significant pressure on household budgets. While headline inflation cooled down, food prices rose by 2.4% year-over-year in September, signaling that the high cost of essentials continues to challenge consumers despite the broader economic improvements. While the pace of food inflation has since moderated in Canada, the overall price of food remains elevated compared to pre-pandemic years.

Gas prices

Gas prices are a major contributor to the CPI basket, and also one of the most volatile; energy prices can change rapidly based on external factors such as changes in the world’s crude prices, supply and demand imbalances, and the production capacity of refineries. Due to this, energy prices can spike or lower dramatically over the course of a month, and can cause dramatic year-over-year base effects in the headline inflation number. This is why core inflation measures, such as the CPI Trim and CPI Median are helpful, as they strip out some of these extreme price swings to better reflect consumer spending trends.

Shelter inflation / mortgage interest costs

Shelter inflation is the largest contributor to the CPI basket; This reflects the high cost of housing in Canada, elevated mortgage rates, and steep rent costs. Shelter inflation in Canada is made up of:

• Mortgage Interest Costs (MIC): This reflects the price-induced changes in the amount of mortgage interest owed by homeowners. This is impacted by both home price changes and how they impact the homeowner’s mortgage balance, as well as the amount of outstanding principal borrowers carry on their mortgages, and the size of mortgage interest payments. With recent rate cuts in 2024, the MIC growth has started to slow. In September, Canadians were paying 16.7% more on their mortgages compared to the previous year, down from the 18.8% increase seen in August. 
• Home replacement costs: This refers to the amount of money it would take to rebuild or repair your home to its original condition at current market prices, not including the land it sits on.
• Rent costs: This index measures how the cost of rent is evolving at a national level. Statistics Canada also provides provincial breakdowns on rent inflation costs.

What is the Canada Core CPI?

In addition to the headline CPI numbers, there are also “core” measures of inflation, which strip out various items to provide a clearer picture of how price growth is evolving. These measures are closely monitored by the Bank of Canada when gauging inflation’s progress, and are key considerations in the central bank’s rate decision making. Core inflation measures are the following:

• CPI Trim: This excludes components of the CPI basket of goods which have price change rages within the tails of the distribution of price changes. More simply put, the CPI trim removes 20% of the weighted price variations at both the top and bottom ends of price changes over the course of the month. This removes volatility and extreme price movement from the basket, which can be based on outlier events; for example, severe weather impacting crop production, and by extension, the price of food.
• CPI Median: The CPI median tracks inflation growth that corresponds to the prices changes within the 50th percentile of the CPI basket within a given month. According to the Bank of Canada, “this measure helps filter out extreme price movements specific to certain components. This approach is similar to CPI-trim as it eliminates all the weighted monthly price variations at both the bottom and top of the distribution of price changes in any given month, except the price change for the component that is the midpoint of that distribution.”
• CPI Common: The CPI common tracks common price changes across the CPI basket’s categories. It uses a factor model (a type of statistical procedure) to determine what these common changes are, which helps remove price changes caused by factors specific to certain basket items.

Canada inflation rate history

Inflation is one of the single most important factors in any country’s economy, including Canada. Whether inflation rates are high or low influences everything from consumers’ purchasing power to Canadian mortgage rates and the overall strength of the Canadian economy. 

Seeing how inflation has fluctuated over the last few years, largely in response to the impact of the COVID-19 pandemic, provides Canadians with valuable insight and helps them better understand where rates may be headed in response.

Inflation growth since the pandemic

How inflation impacts the Bank of Canada

Inflation greatly impacts the cost of borrowing in Canada as it is a key measure considered by the Bank of Canada when it determines the level of its benchmark interest rate.

The Bank of Canada has a mandate to keep the pace of inflation at a 2% target – this is a range where price growth is stable and sustainable, without putting pressure on the economy and consumers. In order to maintain this 2% range, the Bank of Canada (BoC) will increase or decrease its benchmark Overnight Lending Rate (OLR), which Canadian lenders use to set their Prime rate and, by extension, their variable-rate borrowing products. When inflation is running too high, the central bank increases its OLR, to make it tougher to borrow and discourage spending. When the economy is at risk of being too soft, the BoC will cut its OLR to keep the flow of credit going, thereby stimulating the economy.

At its sixth announcement of the year on September 4, 2024, the Bank of Canada lowered its target for the overnight rate by -0.25% from 4.50% to 4.25%. This is the third rate cut implemented by the central bank since March 2020, following the -0.25% rate cuts implemented by the Bank on June 5, 2024 and July 24, 2024.

• The Bank pointed to steadily improving inflation data as the driver of its decision, with July's Canadian CPI having come in at 2.5% and inflation declining in the United States as well. 
• Anyone with a variable-rate mortgage or a home equity line of credit (HELOC) will surely be pleased with the Bank’s decision, as their rates continue to descend from a nearly 20-year high. 
• Although fixed mortgage rates are tied to the bond market and are therefore not directly impacted by the Bank of Canada’s rate cut, bond yields dropped into the 2.7% range following the Bank’s announcement. Some lenders had already begun to reduce their fixed mortgage rates over the last few days in anticipation of this rate cut, and once it became official, more lenders followed suit. 
• Canadians looking to buy a home or whose mortgage is up for renewal should get a rate hold to ensure they can take advantage of the best rate possible. If mortgage rates go down further during the time of your rate hold, you will be eligible for the lowest rate. 
• It will be interesting to see what effect this rate cut has on the housing market. There was a small bump in activity following the Bank’s June 5 rate cut, so three cumulative rate cuts may well incite buyers to come in off the sidelines.

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