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Headline inflation for August surged to 4.0% YoY in Canada, rising seven tenths of a percentage point to beat expectations for a 3.8% rise.
On a monthly basis, prices rose by 0.4%, double the pace expected by the consensus. While the Bank of Canada could have chalked this down to higher gasoline prices given that they ripped 4.6% higher in August alone, the renewed uptick in their favoured underlying measures of core inflation means that the second pause in their hiking cycle this year is under threat. While back in June it was the strength in growth conditions that led the BoC to resume hiking rates twice more to a level of 5%, now it is the uptick in the previously stagnant core inflation metrics. Both the 3-month annualised averages of core-trim and core-median rose by a full percentage point in August to 4.6% and 4.4% respectively, breaking the 4% upper bound that these measures had held since November. It is still too early to confidently call for another BoC hike in the fourth quarter given the slightly negative GDP reading for Q2, signs that the labour market is recalibrating, less hawkish commentary from Governor Macklem at the last BoC meeting, and the fact that there is still one more inflation report before the October meeting.
But the worrying surge in core price pressures means that our view that the Canadian policy rate had peaked is now under credible threat.
Markets are bracing more aggressively for a further rate hike from the BoC, however. Following today’s release, the market-implied odds of an October hike jolted up from 1 in 3 to a coin flip, and one further hike is now fully priced by January. The more hawkish BoC expectations led to a roughly 10bps upshift in the Canadian yield curve, extending the loonie’s oil induced rally. This has seen USDCAD trade just under the 1.34 handle, its lowest level since early August.
After trading in a range of 3.5-4%, the BoC’s preferred measures of underlying inflation have broken to the upside, with the average of core-median and core-trim rising to its highest level since July 2022
The surge in the 3-month core averages reflects both May’s softer figures dropping out of the average as well as strong increases in August.
At an average rate of 4.49%, the latest acceleration in core pressures now sees the BoC facing the dreaded stagflationary cocktail after growth flatlined in the second quarter. After standing out from other developed economies, boasting stronger growth and softer inflation, the Canadian economic outlook now looks increasingly similar to the Eurozone and UK as opposed to the neighbouring US.
Much focus will now be on whether the Canadian economy accelerated back into excess demand in the third quarter, an outcome that would undoubtedly lead to further monetary tightening from the BoC. Here in the absence of timely growth indicators, analysis of the aggregate measures and individual CPI components sheds little light. On an aggregate basis, goods and services prices have shown a volatile back-and-forth dynamic. For instance, July’s price gains were services-led, rising 1.0% on the month as goods prices inched up by 0.2%, but August saw a reversal in that pattern with services gaining 0.1% and goods up 0.7%.
This raises uncertainty for the central bank, which at the start of the year had thought the supply-driven goods inflation had been conquered while demand-oriented services were the main issue.
On a component basis, the picture is also mixed. Shelter provided one of the biggest upward surprises, rising 0.8% MoM. Within the category, mortgage costs (+2.7% MoM) were still the fastest rising component, a natural result of the Bank of Canada’s rate hikes. But outside of mortgage interest, utilities (+1.7%) and rents (+0.7%) also drove the shelter basket higher, with StatsCan noting that eight provinces saw rental prices increase. The rise in shelter costs will be a secular trend, given that the population is now rising at an unprecedented pace even though Canada has the fewest homes per capita in the G7. Politicians have placed a heavy focus on boosting the housing supply in recent months, but their plans will take many years to materialise and are too marginal to generate a significant improvement in housing affordability.
Despite the dreary picture painted by the full data release, one source of optimism was that discretionary categories softened from last month.
Recreation costs were trimmed by -0.9% in August after rising by 2.1% the month before, while restaurant prices edged down to a still-high 0.5% monthly gain. Although this suggests that demand conditions continued to cool in the middle parts of the third quarter, once again the readthrough isn’t consistent as clothing prices rebounded by 1.1% in August after falling by -1.0% in July. As such, we think it is difficult to extrapolate too much from today’s inflation release, but we note that the increased sequential pace of core inflation poses a credible risk that the BoC could be forced to resume its hiking cycle once again in Q4.
Author:
Jay Zhao-Murray, FX Market Analyst