Canadian headline inflation slowed to 1.8% in February. Year-on-year comparisons were affected by last year’s GST/HST holiday, which ran to mid-February, and the removal of the consumer carbon tax in April 2025, which lowered energy CPI. The Bank of Canada’s core trim and median CPI measures eased in February. They averaged 2.3% year-over-year, the slowest pace in almost five years.

Core Inflation Signals Weak Demand

On a three-month annualised basis, these core measures averaged 1% in February. This was below the Bank of Canada’s 2% target. Price pressures linked to supply issues remained for some grocery goods, including beef and coffee. The article links these to production disruption from adverse weather. The article says higher oil prices tied to ongoing Middle East tensions are expected to lift energy inflation in March. It also states an expectation that the Bank of Canada will hold the overnight rate at 2.25% at this week’s meeting. The recent inflation report for February shows a major split that we need to watch carefully. While the main inflation number is low at 1.8%, the core measures, which the Bank of Canada focuses on, have slowed to just 1% on a three-month basis. This weak internal demand is directly at odds with rising external pressures from supply chains and oil prices.

Market Pricing Versus Central Bank Caution

The Bank of Canada will likely hold its overnight rate steady at 2.25% this week, but the swaps market is already pricing in a nearly 60% chance of a rate cut by the June meeting. This creates a disconnect between the central bank’s cautious stance and the market’s dovish expectations. We believe the market may be getting ahead of itself, underestimating the Bank’s concern over new inflation shocks. We must factor in rising energy costs, with WTI crude oil recently trading above $95 a barrel for the first time in over a year. Looking back at the situation in 2022, we remember how persistent energy price shocks forced central banks to stay hawkish even as other parts of the economy cooled. The removal of the consumer carbon tax back in April 2025 is also making year-over-year energy comparisons difficult, giving the Bank another reason to wait. Given this setup, a potential strategy is to position for interest rates remaining higher for longer than the market currently expects. This could involve looking at Bankers’ Acceptance futures (BAX) for later in the year, which seem to be underpricing the risk that sticky, supply-driven inflation will delay any rate cuts. The Bank will likely want to see several more months of clean data before committing to an easing cycle. The clear tension between weak domestic inflation and high commodity prices suggests a period of higher volatility is coming. Traders could use options to profit from this uncertainty, such as buying straddles on interest rate futures. This allows a position to benefit from a significant market move, without having to bet on whether the dovish core data or hawkish oil prices will ultimately dictate the Bank of Canada’s next step. Create your live VT Markets account and start trading now.

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