Canadian Inflation Cools: Why January’s Data Strengthens the Case for a Rate Cut

January’s inflation data delivered an unexpected signal for Canada’s economy—and it may have meaningful implications for interest rates. With Canadian inflation easing more than forecast, investors and policymakers alike are reassessing the likelihood of a potential interest-rate cut by the Bank of Canada in the months ahead.

Canadian inflation, as measured by the Consumer Price Index (CPI), cooled suddenly in January, falling to 2.3% from 2.4% in December. Economists had been expecting January’s inflation reading to remain unchanged from December 2025.

What’s Driving the Latest Shift in Canadian Inflation

Canadian inflation is getting closer to the Bank of Canada’s two-percent target rate. The lower inflation reading was driven by a decline in the price of gasoline and shelter. Gas prices are down 16.7% from a year ago. That’s due largely to the end to the consumer carbon price from last April. The average rent in the country also fell to its lowest level in roughly five years.

These decreases were offset by higher food prices. Food prices advanced 7.3% on an annual basis, compared to a 6.2% gain in December 2025. Some of the acceleration of food inflation can be blamed on the end of a GST tax holiday that ran from December 14, 2024, to February 15, 2025. This resulted in the cost of restaurant meals jumping 12.3% on an annual basis.

Food inflation at stores was up 4.8%. This big increase is a result in part of a weaker Canadian dollar. A lot less fresh food is grown in Canada during the winter months, so imported groceries are susceptible to import prices and fluctuations in currency rates. For comparison’s sake, U.S. food prices were up 2.9% in January.

Core inflation, which is the Bank of Canada’s preferred measure and excludes more volatile changes in food and energy prices, is running closer to the central bank’s two-percent target on a six-month basis.

How Will the January Inflation Data Impact Interest Rates?

It wasn’t all that long ago that money markets were predicting that the Bank of Canada would hold interest rates steady at 2.25% in 2026. TD Economics expected the Bank of Canada to hold interest rates at 2.25% as far out as 2031. Other financial institutions were less optimistic, believing that the Bank of Canada would raise interest rates to 2.5% by the end of 2026 and 2.75% in 2027.

With inflation cooling, though, and the cloudy outlook on what a trade war with the U.S. will do longer-term to the Canadian economy, the odds of an interest-rate cut have just strengthened. Should inflation continue to decelerate, the Bank of Canada could use a rate cut to help stabilize and juice the Canadian economy.

For an interest-rate cut to be in the cards, inflation in Canada would need to decelerate for a few more months. The odds of a cut as part of the Bank of Canada’s next policy decision on March 18 currently stand at 10%.

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