Canada’s Consumer Price Index revealed a huge and unexpected rise in consumer inflation today, possibly jeopardizing interest rate cuts in Canada.

The CPI for April came in at 3.6% today, its highest level since 1991. A cigarette tax increase, large price gains in gasoline, electricity, and fresh fruit drove the increase, with help from clothing, health care, and vehicle prices.

Overall prices rose by 0.7% in April. Excluding food and energy, prices rose by 0.4%, pushing the annual inflation rate to 2.1% from 1.7% in March. This marks the fastest rate of annual core inflation in almost four years.

CIBC World Markets says, “The tag team of costlier food and energy should continue to exert pressure on headline prices as the prime driving and barbeque season approaches. Further price increases in these two volatile components could delay a sustained run below the Bank of Canada’s 3% inflation ceiling until late in the year.”

However, CIBC sees core prices moderating. “An anticipated increase in labour market slack and increasing capacity at the factory level should translate into benign underlying inflation results. Like the central bank, we continue to see the 12-month trend in core prices breaking back below the mid-point of the target band over the balance of the year.”

The question is what the April increase in inflation means for interest rates. TD Bank suggests not much. “While the jump in consumer prices in April may be painful for Canadian consumers, it will not be nearly as painful for the Bank of Canada, which is squarely keeping its focus on underlying inflation trends. In sum, there is very little in today’s report to deter the central bank from easing its policy settings in the months ahead.”

CIBC concedes however that, “Today’s stronger-than-expected CPI report further clouds the outlook for the upcoming Bank of Canada rate date. True, the monthly seasonally-adjusted moves weren’t overly threatening. But the jump in the 12-month core rate, combined with two consecutive upside surprises on the employment front, suggest that the bank may be reluctant to administer an aggressive dose of monetary easing on May 29.

BMO Nesbitt Burns agrees, noting, “Along with yesterday’s news that wage settlements were at a nine-year high, the CPI will cause real discomfort at the bank. The odds of a 25 basis point cut on May 29 just rose sharply.”

The economists at RBC DS Capital Markets Research note that the Bank of Canada drops out the impact of new taxes, such as the new cigarette tax, when looking at inflation. But it still admits, “Even though today’s figures are not believed to reflect a trend increase in underlying inflation, it will grab the bank’s attention, especially in combination with last week’s jump in employment — raising the risk of a 25 bps cut on May 29 in place of a 50 bps move.”

CIBC says that next week’s retail sales report might cast the deciding vote on rate action. “It will be the last meaningful piece of data before the rate decision, where disappointing consumer spending results could still tip the balance in favour of a 50 bps cut.”