News & Analysis

Inflation in Canada cooled more quickly than expected in August, with the headline index down -0.3% on the month and falling in year-on-year terms by 0.6 percentage points to 7.0%.

This marks the second consecutive monthly decline in the headline YoY figure from June’s peak of 8.1%, and similarly to July, was mostly driven by lower gasoline prices and base effects. Analysts expected a milder monthly decline of 0.1% for the MoM rate and 0.3 percentage points for the YoY figure.

Many signs in the report will be viewed with optimism by the Bank of Canada.

The headline inflation rate sits a full percentage point below their 8.0% YoY forecast for the third quarter. In addition, core price pressures, which have been in particular focus given their stickiness, also seemed to stall. CPI excluding food and energy came in flat in August, allowing base effects to cut the YoY figure by three tenths to 5.3%. Out of the BoC’s three preferred measures of core, both core-median (+4.8% YoY) and core-trim (+5.2% YoY)  fell by two tenths. Only core-common (+5.7%), which is based upon a complex econometric factor model as opposed to simple statistical rules, went the other way. Nevertheless, most analysts have been putting very little weight on the core-common rate in recent months as it has been subject to large revisions of late; as a testament to that fact, the indicator’s reading for July was revised upward by five tenths to 6.0%, which is a dramatic revision.

Aside from the softening in core prices, a few other key signals in the report will allow Bank of Canada officials to momentarily catch their collective breath.

For one, price growth for both goods (-0.8% MoM) and services (+0.1% MoM) slowed, suggesting that an easing in elevated supply chain pressures, weaker domestic demand, and tighter monetary policy are all working in sync to slow inflation. Although the bulk of the decline in inflation was driven by lower transportation costs (-2.5% MoM) on cheaper gas (-9.6% MoM), which is heavily exposed to global conditions, some of the most interest-rate sensitive components, such as durable goods (-0.6% MoM) and shelter (-0.1%) saw prices fall, indicating that the quick pace of interest rate hikes is having its desired effect. The evidence suggests that demand is slowing, as discretionary services pertaining to travel were a major driver of the slowing in services inflation overall. Finally, the report also showed that inflation dipped in every single Canadian province, which was yet another sign of a broad-based slowdown in price growth.

Following the release of the data, Canadian markets reacted in a slightly dovish manner, consistent with the idea that a faster-than-expected return to the 2% target removes some of the tail risk that the Bank of Canada will need to tighten policy well beyond the 4% handle.

In accordance with that notion, bond yields fell by 7-9bps across the curve from moments prior to the report’s release, flipping the overall 1-day change from positive to negative and widening the discount on Canadian government bond yields relative to US treasuries. In money markets, expectations for the Bank of Canada’s next meeting in October fell from a fully priced 50bp hike and a 22% chance of 75bps to a fully priced 25bp move with 90% chance of 50bps. As a result, the loonie sold off, with USDCAD pushing half a cent higher and edging closer to yesterday’s 22-month high for the pair.

Falling transportation costs drive the bulk of the slowdown in headline price pressures

 

 

Author: 

Jay Zhao-Murray, FX Market Analyst

 

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