Unexpected rise in inflation in Canada
Inflation in Canada unexpectedly surged in May, throwing a curveball at policymakers who were considering further interest rate cuts next month.
According to Statistics Canada's latest report, the consumer price index (CPI) rose by 2.9% from a year ago, up from 2.7% in April. This increase was driven primarily by higher prices for services. On a monthly basis, the index climbed 0.6%, surpassing expectations for a 0.3% gain. Adjusted for seasonal factors, inflation rose by 0.3%.
The Bank of Canada's core inflation measures, which exclude volatile items like food and energy, also picked up pace, averaging 2.85% annually, exceeding economists' forecasts.
This data marks a turnaround from four months of easing price pressures, prompting cautious optimism among central bank officials. The resurgence in both headline and core inflation is likely to dissuade the Bank from implementing a second consecutive interest rate cut in July, as policymakers assess whether this uptick is temporary or not.
Benjamin Reitzes, rates and macro strategist at Bank of Montreal, remarked, “The inflation path remains uneven, suggesting that the path for rate cuts won’t be straightforward. While a July cut isn’t out of the question, the likelihood has significantly diminished.”
Following the release, the Canadian dollar initially strengthened against the US dollar but later retraced some gains. Meanwhile, the yield on 2-year Canada bonds rose by about nine basis points to four per cent.
Earlier this month, Governor Tiff Macklem and the Bank of Canada reduced the benchmark overnight rate by 25 basis points to 4.75%, initiating a monetary easing cycle. They cited diminishing inflation pressures and growing confidence that inflation would trend towards the target of two per cent.
The next pivotal event will be another CPI report ahead of the Bank's July 24 rate decision. Most economists in a Bloomberg survey anticipate the central bank to keep interest rates unchanged in July, potentially resuming easing in September.
Charles St-Arnaud, chief economist at Alberta Central, cautioned, “While the lack of progress in May reduces the likelihood of a July rate cut, the upcoming CPI release could still influence decisions.”
Governor Macklem reiterated the Bank's stance, suggesting further rate cuts could follow if inflationary pressures ease further. However, policymakers are wary of moving too hastily and undermining progress in controlling inflation.
Bloomberg's analysis noted that the three-month moving average of the inflation rate surged to an annualized pace of 2.52% in May, up from 1.64% in April, indicating broad-based price increases.
Shelter costs, including mortgage interest and rent, were primary drivers of inflation, with mortgage interest costs spiking by 23.3% and rent rising by 8.9% year-over-year. Excluding shelter costs, the CPI increased by 1.5% annually, up from 1.2% in April.
Excluding food and energy, the index rose by 2.9% from a year ago, reflecting increased costs for services, which climbed by 4.6% compared to 4.2% in April.
Food prices also contributed to inflation, rising by 2.4% year-over-year, slightly up from 2.3% in April. Grocery prices saw a notable increase of 1.5% annually, marking the fastest acceleration since June 2023.
Regionally, inflation accelerated in six out of ten Canadian provinces compared to April, with Ontario and Quebec leading the rise.
While the release incorporated updated basket weights from Statistics Canada, analysts noted that these adjustments did not significantly impact the headline CPI change.
Looking ahead, Bloomberg Economics underscored, "The resurgence in inflation suggests the Bank of Canada will proceed cautiously with rate cuts. While one poor inflation report isn’t conclusive, we expect the Bank to maintain its current stance in July. With potential inflation risks from housing prices and limited divergence from the Federal Reserve's policy, we anticipate the Bank to adjust its rate target cautiously, likely on a quarterly basis."
