Economist Royce Mendes says most of the signs of problematic core inflation can be traced to “a few very idiosyncratic one-off factors” that converged in April consumer price index data. (Photo by Artur Widak/NurPhoto via Getty Images) · NurPhoto via Getty Images
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 “sticky” core inflation as “nothing more than an illusion.”
The BoC’s focus should therefore shift to Canada’s economy, which is currently struggling with weak demand and high unemployment, he says.
“I 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,” Mendes said in an interview with Yahoo Finance Canada.
He says most of the signs of problematic core inflation — measures that remove taxes and items with erratic pricing to better show underlying trends — can be traced to “a few very idiosyncratic one-off factors” that converged in April’s consumer price index (CPI) data.
Mendes points to three temporary factors:
Rents: Statistics Canada data showed a sudden surge, even as market-based measures of asking rents were falling. “That doesn’t mean StatCan is wrong,” Mendes said, “but it probably takes six to nine months for official data to catch up.”
Energy margins: Providers raised prices in April after the carbon tax was removed, offsetting the consumer’s discount. “That’s a one-time factor,” Mendes said.
Tariffs: Retaliatory tariff impacts peaked earlier this year, Mendes argues. By July, tariff-exposed categories had dropped to their smallest share of inflation readings since 2024.
“With those three things converging, April had this really big core inflation print,” Mendes said. “And you move three months later and I think everyone is sort of coming to the conclusion that underlying inflation is really not that strong.”
With those pressures easing, Mendes argues that the market is not fully pricing in how much more stimulus the BoC is likely to deliver.
“What 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,” he said.
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 — the extra compensation investors demand for holding long-term bonds. “The Bank can chart its own course for monetary policy and has very few constraints,” Mendes said. “But that may not mean that 10-year bond yields fall — or five-year bond yields fall, which matter a lot for mortgages in Canada.”
Story Continues
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.
“That’s not even disinflation — that’s deflation in some particular products,” he said.
Mendes also expects rent inflation to cool as official data catch up to market declines, 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. “It’s hard to argue with that. There’s no seasonality in year-over-year rates,” Mendes said.
On housing, Mendes acknowledges that if borrowing costs fall too quickly, rate cuts could reignite activity. But he notes that slowing population growth, condo market weakness, and tighter foreign-buyer rules mean “the risks to the housing market right now are much more two-sided than they have been in some time.”
He argues that inflation and stagflation risks have in fact diminished since the removal of tariffs. “The risk to fewer rate cuts than I’ve pencilled in is really that the economy turns out better than expected and doesn’t require as much medicine,” Mendes said.
Looking ahead, he says there is a strategic opportunity at stake. Global investors are questioning their heavy reliance on U.S. assets, and Canada — with AAA credit, strong institutions and relative political stability — could attract more capital.
“But getting the economy back to full health is key,” Mendes said. “The longer the Bank of Canada waits, paralyzed by uncertainty about inflation, the less chance there is for those flows to come in.”
John MacFarlane is a senior reporter at Yahoo Finance Canada. Follow him on X @jmacf.
Download the Yahoo Finance app, available for Apple and Android.