Higher Oil Prices Ignite Canadian CPI Growth

In March, the Consumer Price Index (CPI) rose by 2.4 per cent year-over-year (y/y). This was higher than February’s 1.8 per cent increase.

Key insights

In March, headline CPI increased by 2.4 per cent (y/y)—a sharp rise from February. The conflict in the Middle East and the closure of the Strait of Hormuz sent oil prices soaring above $110 USD per barrel in March. In Canada, gasoline and other fuel prices mounted—directly impacting the CPI. In March, gasoline was 5.9 per cent higher than a year ago—a comparison that is partly blunted by the addition of the consumer carbon tax on gasoline prices at the same time last year. In April, base effects from the carbon tax removal will evaporate, and year-over-year gas price growth will be more pronounced. In March, food prices also rose by 4.0 per cent and are expected to rise further as higher transportation costs spur suppliers to add fuel surcharges to deliveries. However, core inflation measures, which typically exclude gasoline, remained steady. Excluding food and gas, the CPI rose by 1.9 per cent in March.

The federal fuel excise tax break will provide limited inflation relief—but with inflation driven by factors beyond the control of Canadian policymakers, it plays another role. Starting on April 20, the measure will remove about 10 cents from the price of a litre of gasoline and 4 cents from the price of diesel. The tax will also be removed from jet fuel. However, gasoline prices have increased by about 43 cents since late February, and even after the tax break, prices will remain substantially higher than Canadians have recently been accustomed to. The break is also temporary, running from mid-April to early September. On balance, the tax break’s effectiveness as a direct inflation-easing measure is limited. The drop in gasoline prices will only remove about 0.1 percentage points from all-items CPI inflation this year. However, the cut provides psychological relief, which may cool consumer inflation expectations. When consumers expect higher inflation, this can become self-fulfilling through higher wage demands. The visibility of gas prices makes them prominent in consumer psychology and knocking them down—even by 10 cents—will provide some reassurance to anxious Canadian consumers.

While its impacts will be highly uneven, the energy shock will be a net positive for some provinces. Higher energy prices followed closely on the heels of Alberta’s provincial budget release, which anticipated a deficit of $9.4 billion. However, with oil prices more than $30 higher than supposed in the budget ($60.50 WTI), much of this deficit will be cleared if higher prices persist. For Canada, the fuel excise tax break will cost about $2.4 billion, though higher revenues from corporate taxes on energy producers will help to offset this cost. Money saved at the pump will also give Canadians more room to spend elsewhere—though weaker growth stemming from higher energy prices, along with waning employment gains, will put pressure on consumer spending (leaving other government revenues, including income and sales taxes, softer). On balance, the net impact on federal government finances could be neutral contingent on how long oil prices remain elevated, though provinces without a significant oil and gas industry will face stormier circumstances.

Monetary policy tools are generally ill-equipped to contain the inflationary effects of supply shocks, particularly when the economy is already weak. Raising interest rates to cool inflation weakens the economy further, raising borrowing costs when households and businesses are already coping with higher energy costs. On the other hand, lowering interest rates to stimulate economic activity threatens to send inflation even higher, raising the likelihood that a temporary energy price spike could translate into persistent inflation. How the Bank of Canada should respond will depend on how weak the economy gets against how high inflation rises beyond its 2.0 per cent target. Central to this calculus is how long the conflict in the Middle East and its impact on energy markets lasts. Our latest forecast anticipates that oil prices will decrease as hostilities wane and energy shipments move more freely. For the Bank, recent experience may loom large, however: central banks faced criticism for labelling the 2022 supply shocks as “transitory” through inflation soared for a prolonged period soon thereafter. This experience could engender a stronger inclination to act sooner rather than later. The Bank’s Governing Council will ultimately need to make a call on when the conflict will subside in the leadup to its next monetary policy decision on April 29.

For more details about the impact of the shifting geopolitical landscape and our research on Canada’s place in a changing world, please read more here.