By Promit Mukherjee and Ismail Shakil
OTTAWA (Reuters) -Canada's annual inflation rate slowed significantly more than expected to 2.9% in January and core price measures also eased, data showed on Tuesday, bringing forward bets for an early interest rate cut.
It was the first time in seven months that headline inflation has dipped below 3%. That prompted money markets to hike bets for a rate cut in April to as much as a 58% chance from a 33% chance before the figures were published.
The January inflation figure "will certainly raise the odds on an April rate cut," said Karl Schamotta, chief market strategist at Corpay.
The Bank of Canada's next policy announcement is March 6, and expectations are that rates will stay on hold at a 22-year high of 5%. Analysts polled by Reuters had forecast inflation to tick down to 3.3% from 3.4% in December.
Prime Minister Justin Trudeau, whose Liberals are trailing in the polls amid opposition attacks over the soaring price of accommodation and food, described the data as good news.
"We are optimistic that the Bank of Canada will start bringing down interest rates sometime this year, hopefully sooner rather than later," he told reporters in Vancouver.
Month-over-month, the consumer price index was unchanged, compared with a forecast of a 0.4% rise, Statistics Canada said.
The Bank of Canada targets inflation at 2%. Two of its three core measures of underlying inflation also edged down. CPI-median slowed to 3.3%, the lowest since November 2021, while CPI-trim decreased to 3.4%, the lowest since August 2021.
The three-month annualized rate of the combined figures decelerated to 3.2% in January from 3.6% in the prior month.
The BoC said last month its thinking had shifted to how long rates must stay at the current level. At the same time, it did not completely rule out another rate hike, citing persistence in underlying inflation.
"The key takeaway here is that Bank of Canada can seriously consider cutting rates," Doug Porter, chief economist at BMO Capital Markets.
The BoC projects headline inflation will remain around 3% in the first half of 2024, before cooling down to 2.5% by end-year.
The central bank said last month that while interest rates had helped to bring down overall inflation, which touched a peak of 8.1% in June 2022, categories including shelter costs have fed underlying pressures.
Shelter price inflation accelerated to 6.2% in January from 6% in December. Rental inflation continued to show upward momentum and accelerated 7.9% in January from 7.7% in December.
Excluding shelter, inflation is running at 1.5% annually, Tu Nguyen, economist with accounting & consultancy firm RSM Canada said, adding if this trend continues, the central bank might start cutting rates in April.
The Bank should not focus on housing costs when setting rates because they are likely to keep rising, Nguyen said.
Some economists still see the first rate cut in June.
"The Bank of Canada will likely remain cautious in the face of still-strong wage gains, firm services prices, and the reality that core inflation is still holding above 3%," said Porter from BMO.
Economists Nathan Janzen and Abbey Xu from RBC said the BoC would wait for firmer signs of easing inflation, and they expect first rate cuts at mid-year.
Food inflation cooled to 3.9% last month from 5% in December. Prices of store-bought food rose 3.4% - the slowest pace since August 2021 - also putting downward pressure on headline inflation.
Excluding volatile food and energy, prices rose 3.1% compared with a 3.4% rise in December.
The Canadian dollar reversed an early morning trend and weakened 0.25% to 1.3522 against the U.S. dollar at 1915 GMT. The two-year government bond yield dropped 13.9 basis points to 4.163%.
The largest contributor to headline deceleration in January was lower gasoline prices, which fell 4% on an annual basis, Statscan said. Month-over-month, gasoline prices fell 0.9%, marking the fifth consecutive monthly decrease.