Canada’s annual inflation rate dropped more than expected in June to 2.8%, a 27-month low, though food prices remain elevated and core measures of consumer prices remained stubbornly high.
Analysts polled by Reuters had forecast inflation to drop to 3.0% from 3.4% in May. Month-over-month, the consumer price index was up 0.1%, also lower than forecast of a 0.3% gain.
But there was less progress when the less volatile measures of inflation are stripped out. The average of two of the Bank of Canada’s core measures of underlying inflation, CPI-median and CPI-trim, came in at 3.8%, only down one-tenth of a percentage point from May.
The Canadian dollar and government bonds yields initially moved modestly lower after the data release. But the loonie soon recovered all those losses, and was trading higher by late afternoon. Government bond yields were nearly unchanged by the end of the North American trading day.
Meanwhile, implied interest rate probabilities based on trading in swaps markets show about an 80% chance the Bank of Canada will hold interest rates unchanged at its next policy meeting on Sept. 6, according to Refinitiv Eikon data. That’s up from about a 76% probability prior to this morning’s inflation data release.
Here’s a detailed look at how money markets are pricing in further moves in the Bank of Canada overnight rate, as of 1030 am ET. The current Bank of Canada overnight rate is 5%. While the bank moves in quarter point increments, credit market implied rates fluctuate more fluidly and are constantly changing. Columns to the right are percentage probabilities of future rate moves.
And, here’s how the swaps pricing looked just prior to the 8:30 a.m. ET inflation report:
Here are excerpts from research notes on how economists are reacting:
David Rosenberg, founder of Rosenberg Research
Of course, the inflation-phobes will never be silenced and are saying that inflation is being skewed down by gasoline, that the process is about to stop, and that the depressed year-ago base effects will reverse course (true, but only for the next three months). But let’s stick to the facts. The CPI (not seasonally adjusted) came in at +0.1% MoM in June and the same economists fretting over the situation were calling for +0.3%. The headline inflation rate was supposed to ease to +3.0% but instead softened to +2.8% (from +3.4% in May) to stand at the lowest pace since March 2021. On a MoM seasonally-adjusted basis, the CPI came in at just +0.1% as well and that followed 0.0% in May for the weakest back-to-back pulse in three years. For all the talk of how this is all just a gasoline story, the core CPI came in at +0.1% for the second month in a row as well, and we haven’t seen something like this since February-March 2021, which was a full year before the BoC took on this John Crow type of aggressive policy tightening cycle.
The core rate of inflation (ex. food & energy) has declined now for seven months in a row — from +5.4% a year ago to +3.6% today (was +3.8% in May). The six-month trend is down to a +2.9% annual rate, and over the three months to June, now at a mere +2.5%. But the policy hawks will focus on the key BoC core measures, which came in a bit hotter at +0.3% sequentially and sitting too high for the central bank’s liking at +3.9% YoY for the median and +3.7% for the trimmed-mean metric (while both peaked near 5.5%, the improvement has been on the slow side as of late).
That said, I did find quite a few positive tidbits in the CPI report. The index that strips out the 8 most volatile items and indirect taxes came in at less than +0.1% MoM (+0.07% to the second decimal place) after a similar uptick in May. The YoY trend here was +6.1% a year back, slowed to +3.6% in May, and now to +3.2% in June. The three-and six-month pace are down to +2.7% at an annual rate, which is encouraging in that the momentum is subsiding in this underlying inflation barometer.
We have this situation on our hands where the Bank of Canada itself is causing the inflation it is so worried about. Mortgage interest surged +1.6% MoM and by +30.14% from year-ago levels — strip this out, and the YoY inflation rate is at the Bank’s 2% target right on the nose. The core is at +2.4%, but the three-and six-month trends are south of a +2.0% annual rate on this score. That is the key: strip out mortgage costs, and the other 95% of the pricing pie is down to the Bank’s target of 2%. The BoC, hopefully, can see this. It has talked the markets into thinking another one or two more rate hikes are coming — that would be a mistake, in my opinion — completely unnecessary. But like the Fed, the BoC is focused squarely on lagging and contemporaneous economic indicators — a recession is still the odds-on bet.
Andrew Grantham, senior economist, CIBC Capital Markets
With the deceleration in headline inflation largely due to gasoline prices being compared to the very peaks witnessed in 2022, and with core measures of inflation showing decidedly mixed measures, the weaker headline figure doesn’t mean we can sound the all clear for interest rates just yet. Headline CPI rose by 0.1% in June on both a seasonally adjusted and unadjusted basis. The 2.8% annual rate was the lowest since March 2022, with the deceleration mainly due to gasoline prices which were down 21.6% year-over-year in June following an 18.3% decline in May. A smaller monthly increase in car prices this year compared to last year also helped bring the headline year-over-year rate lower, as supply chain disruptions have eased relative to 2022. Mortgage interest costs remained the primary driver of year-over-year inflation, and excluding that component inflation sat at exactly 2.0% in June.
Excluding food and energy, prices rose by a mere 0.1% m/m for a second month in a row on a seasonally adjusted basis. Our preferred measure of core inflation, which excludes mortgage interest costs as well because these are being directly affected by BoC rate hikes, showed prices were little changed on the month and up only 1.6% on a three-month annualized basis. The old Bank of Canada core measure CPI-X showed a deceleration to 2.6% on a three-month annualized basis. However, the gap between some of these traditional core measures and the Bank of Canada’s new core measures appears to be widening again, with these new measures still suggesting a stickiness of underlying price pressures well above the 2% inflation target. Indeed, CPI-trim and median both printed above consensus expectations in June, with the average accelerating to a 3.8% pace on a three-month annualized basis (from 3.7% in the prior month).
Headline inflation will likely creep back above 3% in the coming months, as base effects from lower gasoline prices become less generous. However, it was the stickiness of core inflation measures which was a concern for the Bank of Canada, and with CPI-trim and median showing little further progress towards the target band there remains a very real risk that interest rates could be raised again after the summer. With our preferred core measures of inflation already showing clearer signs of waning price pressure, we continue to think that the Bank of Canada is overshooting what was necessary in order to bring price pressures under control, and see inflation dipping below 2% in the second half of next year (three quarters earlier than the Bank’s MPR forecast for a return to 2% by mid-2025).
Royce Mendes, managing director & head of macro strategy, Desjardins Securities
Inflation has fallen into the Bank of Canada’s target range, but there are signs pointing to slower progress from this point on. ... The latest moves have been predicated on sharp declines in cell phone services prices, which doesn’t provide any assurance that this deceleration can be maintained.
The Bank of Canada’s preferred measures of core inflation, which exclude significant moves in individual categories, shows that underlying price pressures remain sticky. The three-month annualized rate of the core median measure remained at 3.6%, while the trimmed mean indicator accelerated to 4.0% from 3.9% in May. According to our calculations, the core-services excluding shelter measure was also down just a tick in June to 4.8%. As a result, there’s scope for headline inflation to reaccelerate in the months to come as some of the recent progress can be chalked up to one-off moves lower in prices.
That said, despite signs of sticky underlying inflationary pressures and resilience in economic activity indicators, the Bank of Canada has given itself a long time to reach the 2% target. The latest projections from the central bank suggest a very gradual deceleration in price growth, with inflation not reaching 2% until mid-2025 – two years from now. As a result, after raising rates twice at consecutive decision dates, we continue to believe the Bank of Canada is willing to be more patient this fall even if there is an uptick in inflation. As time passes more mortgages will renew at higher rates, more excess savings will be exhausted, and more pent-up demand will be satisfied.
Matthieu Arseneau, Alexandra Ducharme, and Emma Patard, economists with National Bank Financial
Was the Bank of Canada right to lose patience with the lack of progress on the inflation front and resume rate hikes in June? In light of this morning positive development on the inflation front, we continue to believe that the additional tightening was premature and perilous, as the economy has yet to feel the full impact of the increases applied since the start of monetary policy tightening. Some underlying inflation measures are still running at an uncomfortable level for the central bank but those concerns could abate in the coming months. Indeed, the labour market has already begun to ease, judging by the rise in the unemployment rate, the fall in the vacancy rate and the decline in wage pressures in a context of declining corporation profits. The profitability challenge will make companies much more cautious in the months ahead, particularly with the economic slowdown we expect to see, given that monetary policy is the more restrictive in real terms since 2009 and the tightest among G7 countries
Stephen Brown, deputy chief North America economist, Capital Economics
The problem for the Bank is that the easing of overall price inflation was concentrated in a small handful of items. The CPI-trim and CPI-median core measures, which strip out extreme price moves in individual items, rose by 0.3% m/m in June – higher than the 0.2% m/m increases in May and keeping the annual rates elevated at an average of 3.8%. Meanwhile, the annual rate of energy deflation in June of -14.6% is likely to mark the trough, with a rebound taking overall headline inflation back above 3.0% in the coming months. The upshot is that, while some parts of the June CPI data lend support to our forecast that the Bank will keep its policy rate at 5.0% over the rest of the year, it is still too soon to rule out another rate hike altogether.
Benjamin Reitzes, managing director, Canadian rates & macro strategist, BMO Capital Markets
Base effects played a role this month as well, as prices were still firm a year ago, helping cut the yearly pace. However, the next couple of months were much tamer in 2022, so it will be more challenging for inflation to slow in the near-term. Nonetheless, the better-than-expected headline result is somewhat encouraging as it is a step in the right direction bringing down inflation expectations. ...
Core inflation metrics weren’t quite as encouraging. The BoC’s favoured measures, Median and Trim, both slowed a tick on a yearly basis to modestly below 4%. However, on a 3-month annualized basis, the Median was steady at 3.6% and the Trim actually accelerated to 4%. Just to make things a bit more convoluted, the other core measures showed some slowing. Canada’s old core, CPIX, slowed half a point to 3.2% y/y, while the 3-month annualized rate slipped to 2.7%. And, CPI ex. food and energy also slowed half a point to 3.5% y/y, with the 3-month rate falling to 2.5%. It’s worth noting that even if the Trim and Median rise 0.3% m/m in July, the 3-month annualized rates will fall into the low-3s, so there’s likely some good news coming next month.
Key Takeaway: The June CPI report had a little something for everyone, with the headline rate slowing more than expected, but the BoC’s core metrics remaining sticky. However, the improvement in the old core (CPIX) and ex. food & energy provides a bit of offsetting good news. With another CPI report coming before the next meeting, the BoC will be patiently waiting for more data as they head into their August quiet period.
Claire Fan, analyst with RBC
Expectations for headline inflation rate to slow back to target range by mid-2023 have largely been correct. But the BoC’s preferred core measures are proving much stickier, in part supported by resilience in domestic consumer spending. The BoC last week acknowledged that higher rates are already having an impact, just not to the extent as expected to-date. The central bank is also clearly willing to hike interest rates further if necessary. We continue to expect the full impact of rate hikes to-date to come through gradually, slow spending over the second half of this year and for that to push the central bank back on the sidelines with no additional interest rate hikes this year.
Leslie Preston, managing director & senior economist, TD Economics
Canadian inflation continued to make encouraging progress in June. However, the cooling in headline inflation is benefitting from sizeable base effects, due to the favourable comparison to high energy prices last June. The Bank of Canada (BoC) is watching its preferred core measures – CPI-trim and median – which continue to show glacial progress.
BoC Governor Macklem emphasized last week that the Bank has become worried about the persistence of underlying inflation pressures in the economy. The June inflation data likely provides some reassurance that things are moving in the right direction, but not fast enough for the Bank of Canada lets its guard down.
Tiffany Wilding, managing director and economist, PIMCO
This release is unlikely to be a cause for celebration at the Bank of Canada. Although they will be happy to see a continued moderation in headline inflation, the continued stickiness in their favoured core metrics leaves the door open for future rate hikes but is likely not enough to justify one on its own. ... With July CPI still to be released before the September meeting, the interest rate decision is likely to be influenced by whether the above core inflation measures finally break lower on a 3-month moving average basis as the strong April release moves out of the averaging period.
Darcy Keith