Canadian inflation rose in April, mainly due to higher energy prices and fading base effects. The rise in headline inflation was described as overstating underlying price pressures.
Core inflation measures eased, with CPI-trim and CPI-median averaging 2.1% year-on-year in April, down from 2.3% in March. Broader price pressures were described as moderating.
Headline Inflation Driven By Energy
Higher oil prices were linked to higher headline inflation and weaker household purchasing power. The data indicated that elevated oil prices were unlikely to restart economy-wide inflation pressures.
Food and shelter continued to add more than other categories to inflation. At the same time, broader price pressures were easing alongside soft labour market conditions.
Upside inflation risks were said to increase if energy prices stay high for longer. The April figures were used to support a view that the Bank of Canada will keep rates unchanged through the rest of 2026.
It appears the April inflation report is giving a false signal, with the headline number jumping to 3.1% mostly because of energy costs. We see that underlying price pressures are actually cooling, as core measures like CPI-trim and CPI-median fell to an average of 2.1%. This divergence suggests the Bank of Canada is unlikely to react to the headline noise.
Market Positioning And Policy Outlook
Given this view, the market may be overpricing the odds of a Bank of Canada rate hike in the coming months. We believe that derivatives tied to the CORRA rate are pricing in too much uncertainty, creating an opportunity to bet on stability. This situation is reminiscent of the energy price scare in late 2025, which the Bank correctly identified as temporary and chose not to act upon.
This expected inaction from our central bank contrasts with the more hawkish stance of the U.S. Federal Reserve, which is still contending with stickier inflation south of the border. With the U.S. economy recently posting 2.2% annualized growth for Q1 2026 versus our own sluggish 1.5%, this policy divergence should continue to put downward pressure on the Canadian dollar. We see value in buying call options on the USD/CAD pair, targeting a move towards 1.39 over the next quarter.
The report also highlights that high energy prices and shelter costs are squeezing households, which is supported by recent data showing retail sales growth slowing to just 0.2% month-over-month. This points to a strategy of using options to favour the energy sector, which benefits from high commodity prices, while taking a more defensive position on consumer discretionary stocks. The weakness in the labour market, with the unemployment rate holding at 6.3%, further supports this cautious view on the Canadian consumer.
Overall, the message is that the Bank of Canada will remain on hold for the rest of 2026, creating a predictable policy environment. This suggests that implied volatility in Canadian interest rate markets is likely too high. Traders should consider strategies that profit from falling volatility, such as selling strangles on three-month Bankers’ Acceptance futures, as the market comes around to the view that the Bank will look past the current headline inflation.
