By Promit Mukherjee

OTTAWA (Reuters) – Canada’s annual inflation rate slowed in December, data showed on Tuesday, aided by a sales tax break that began mid-month, reducing prices for alcohol, restaurant foods, and children’s clothing.

The annual inflation rate dropped to 1.8%, slightly lower than expected and a tick below the previous month’s 1.9%. On a month-on-month basis, the consumer price index contracted by 0.4%.

On an annual basis, prices for alcoholic beverages purchased from stores declined 1.3% in December, compared with a 1.9% increase in November, while food purchased at restaurants dropped 1.6% in December from a rise of 3.4% the previous month.

The prices included in the Consumer Price Index (CPI) account for all excise and other taxes paid by consumers; thus, any tax break naturally lowers the recorded prices.

The sales tax break, impacting a tenth of the CPI basket components, will continue until mid-February, offering a full month of exemption in January versus 18 days in December, according to Statscan.

Analysts polled by Reuters forecasted the annual inflation rate at 1.9% with a contraction of 0.4% month-on-month.

The steady drop in prices, which has remained at or below the Bank of Canada’s target of 2% since August, has enabled the bank to slash its key policy rate by 175 basis points since June, down to 3.25%.

A further dip in inflation could prompt the central bank to cut rates again next week, though BoC Governor Tiff Macklem indicated last month that further rate reductions would be gradual.

Currency markets are predicting an 81% chance of a 25 basis point rate cut on January 29.

The Canadian dollar was trading down 0.90% to 1.4435 against the dollar, or 69.27 U.S. cents.

“Overall, there are many moving pieces and temporary factors impacting the inflation data at the moment,” said Andrew Grantham, senior economist at CIBC Capital Markets. “But… underlying price pressures seem close to 2%, and we expect a 25 bp reduction in interest rates from the Bank of Canada next week,” he added.

The BoC’s preferred measures of core inflation, CPI-median and CPI-trim, also edged down toward the 2% mid-point of the bank’s 1-3% target range. CPI-median eased to 2.4% from 2.6% in September, while CPI-trim dropped to 2.5% from a downwardly revised 2.6% in the prior month.

Shelter prices, including rent and mortgage costs, rose 4.5% in December year-over-year, slightly lower than the prior month but still elevated.

Year-over-year, gasoline prices rose 3.5% in December compared to a 0.5% decline in November, mainly due to a base-year effect, with prices having significantly dropped in December 2023. Statscan noted that on a month-on-month basis, prices fell 0.6% in December 2024.