Economist Royce Mendes says most of the signs of problematic core inflation can be traced to \u201ca few very idiosyncratic one-off factors\u201d that converged in April consumer price index data. (Photo by Artur Widak\/NurPhoto via Getty Images) \u00b7 NurPhoto via Getty Images <\/p>\n
Markets are underestimating how much more monetary stimulus the Bank of Canada (BoC) will deliver, argues Desjardins Group economist Royce Mendes, who dismisses the prevailing fears of \u201csticky\u201d core inflation as \u201cnothing more than an illusion.\u201d<\/p>\n
The BoC\u2019s focus should therefore shift to Canada\u2019s economy, which is currently struggling with weak demand and high unemployment<\/a>, he says.<\/p>\n \u201cI think it’s really time to move the inflation worries to the back burner and start focusing, in terms of Bank of Canada policy or fiscal policy, on supporting the economy, with the unemployment rate near seven per cent,\u201d Mendes said in an interview with Yahoo Finance Canada.<\/p>\n He says most of the signs of problematic core inflation \u2014 measures that remove taxes and items with erratic pricing to better show underlying trends \u2014 can be traced to \u201ca few very idiosyncratic one-off factors\u201d that converged in April’s consumer price index (CPI) data<\/a>.<\/p>\n Mendes points to three temporary factors:<\/p>\n Rents:<\/strong> Statistics Canada data showed a sudden surge, even as market-based measures of asking rents were falling. \u201cThat doesn\u2019t mean StatCan is wrong,\u201d Mendes said, \u201cbut it probably takes six to nine months for official data to catch up.\u201d<\/p>\n<\/li>\n Energy margins:<\/strong> Providers raised prices in April after the carbon tax was removed, offsetting the consumer\u2019s discount. \u201cThat\u2019s a one-time factor,\u201d Mendes said.<\/p>\n<\/li>\n Tariffs:<\/strong> Retaliatory tariff<\/a> impacts peaked earlier this year, Mendes argues. By July, tariff-exposed categories had dropped to their smallest share of inflation readings since 2024.<\/p>\n<\/li>\n<\/ul>\n \u201cWith those three things converging, April had this really big core inflation print,\u201d Mendes said. \u201cAnd you move three months later and I think everyone is sort of coming to the conclusion that underlying inflation is really not that strong.\u201d<\/p>\n With those pressures easing, Mendes argues that the market is not fully pricing in how much more stimulus the BoC is likely to deliver.<\/p>\n \u201cWhat you should expect to see is that shorter-term bond yields, money market interest rates will see an adjustment that is not currently anticipated or implied by current market pricing,\u201d he said.<\/p>\n Longer-term borrowing costs, including mortgage rates, might not fall as much, Mendes says, because rising global bond yields can blunt the effect of domestic rate cuts. This is due to elevated term premia \u2014 the extra compensation investors demand for holding long-term bonds. \u201cThe Bank can chart its own course for monetary policy and has very few constraints,\u201d Mendes said. \u201cBut that may not mean that 10-year bond yields fall \u2014 or five-year bond yields fall, which matter a lot for mortgages in Canada.\u201d<\/p>\n Story Continues <\/p>\n The removal of retaliatory tariffs is a significant driver of the improving inflation outlook. Mendes says some grocery companies expect prices to fall as a result.<\/p>\n \u201cThat\u2019s not even disinflation \u2014 that\u2019s deflation in some particular products,\u201d he said.<\/p>\n Mendes also expects rent inflation to cool as official data catch up to market declines<\/a>, with about an eight-month lag. And he points out that year-over-year inflation rates, which are not distorted by seasonal adjustments, are already below two per cent. \u201cIt\u2019s hard to argue with that. There\u2019s no seasonality in year-over-year rates,\u201d Mendes said.<\/p>\n On housing, Mendes acknowledges that if borrowing costs fall too quickly, rate cuts could reignite activity. But he notes that slowing population growth<\/a>, condo market weakness<\/a>, and tighter foreign-buyer rules mean \u201cthe risks to the housing market right now are much more two-sided than they have been in some time.\u201d<\/p>\n He argues that inflation and stagflation risks have in fact diminished since the removal of tariffs. \u201cThe risk to fewer rate cuts than I\u2019ve pencilled in is really that the economy turns out better than expected and doesn\u2019t require as much medicine,\u201d Mendes said.<\/p>\n Looking ahead, he says there is a strategic opportunity at stake. Global investors are questioning their heavy reliance on U.S. assets, and Canada \u2014 with AAA credit, strong institutions and relative political stability \u2014 could attract more capital.<\/p>\n \u201cBut getting the economy back to full health is key,\u201d Mendes said. \u201cThe longer the Bank of Canada waits, paralyzed by uncertainty about inflation, the less chance there is for those flows to come in.\u201d<\/p>\n John MacFarlane is a senior reporter at Yahoo Finance Canada. Follow him on X @jmacf<\/a>.<\/p>\n Download the Yahoo Finance app, available for Apple<\/a> and Android<\/a>.<\/p>\n \n