Core Inflation Stays Hot: Why Canada's Rate Cut Hopes Are Fizzling

Canada's central bank faces a precarious balancing act as stubborn core inflation metrics—Trim CPI and Median CPI—remain anchored near 3%, well within the upper threshold of the Bank of Canada's (BoC) 1%-3% target range. This resilience undermines expectations for near-term rate cuts, complicating efforts to support an economy buffeted by trade tensions and slowing growth. Investors must recalibrate portfolios to prioritize defensive sectors while bracing for prolonged uncertainty.

Core Inflation: The Elephant in the Room

The BoC's preferred gauge, the Trim CPI, has remained at 3.0% year-over-year for two consecutive months, while the Median CPI edged up to 3.0% in June. These figures, which strip out volatile components like energy and food, reveal a persistent underlying inflation problem. Despite headline inflation cooling to 1.9%—a welcome respite—the core measures signal that businesses are still passing through cost pressures to consumers.

Why does this matter? The BoC's next policy decision on July 30 hinges on whether these metrics show meaningful progress toward its 2% target. Analysts now widely expect the central bank to hold rates steady, delaying any easing until September or later. “The core data leaves little room for cuts,” said one economist, noting that the BoC is wary of premature stimulus in an environment where tariff-driven cost pressures could resurge.

Trade Wars and the Inflation Shadow

Trade disputes with the U.S. loom large. Canadian countermeasures to U.S. tariffs now cover 60-86% of imports, with dairy sectors facing potential 35% retaliatory duties. While tariff impacts on inflation have been muted so far—June's CPI showed only marginal effects—the lag in data means the full economic toll may not surface until late 2025. Food and auto prices, already under pressure, could accelerate if trade tensions escalate.

Shelter costs, a major inflation driver, also present risks. Rent declines have yet to fully materialize in CPI data, suggesting a delayed lag in housing market adjustments. With mortgage rates still elevated, the sector's contribution to inflation could remain stubbornly resilient.

Investment Implications: Go Defensive, Stay Nimble

The prolonged inflation standoff favors defensive sectors and rate-resistant equities:

1. Utilities: Companies like Hydro One (HUN.TO) and Fortis (FTS.TO) offer stable cash flows insulated from rate cuts. Their low beta profiles make them a hedge against market volatility tied to BoC policy uncertainty.
   

2. Rate-Sensitive Equities: Firms with strong balance sheets and pricing power, such as consumer staples giants Loblaw (Loblaws Companies Limited (L)) and Metro (FRU.TO), can navigate elevated rates better than their peers. Their exposure to grocery inflation—a key driver of CPI—also positions them to capitalize on cost pressures.

3. Short-Term Bonds: Investors should favor 1-3 year government bonds to lock in current yields. The BoC's reluctance to cut rates means shorter durations offer better risk-adjusted returns than long-dated bonds.

Risks to Monitor

• Tariff Escalation: A U.S. dairy tariff would directly hit food inflation, forcing the BoC into a tighter corner.
• Labor Market Resilience: While job gains remain strong, a sudden slowdown could pressure the BoC to cut rates despite high core inflation.
• Global Commodity Prices: A rebound in oil prices (e.g., due to OPEC+ cuts) would reignite headline inflation, complicating the BoC's messaging.

Conclusion: Time to Pivot

Investors should reduce exposure to cyclical sectors like retail and autos, which rely on consumer spending and rate cuts. Instead, focus on sectors that thrive in an environment of prolonged uncertainty. The BoC's dilemma—whether to prioritize inflation control or economic support—means clarity on policy direction won't come soon. Until core inflation drops meaningfully below 3%, portfolios must prioritize stability over growth.

The writing is on the wall: Canada's inflation battle isn't over yet. Stay defensive.