News & Analysis

June’s CPI report today didn’t settle the debate over whether the BoC has hit its terminal level at 5% or whether one further hike would ensue at either September or October’s meeting.

While on the one hand, headline inflation in Canada fell 0.6 percentage points to 2.8% in June, below the Bank’s projected Q4 2023 rate of 2.9%, and services inflation fell, recording its slowest month of price gains this year at just 0.1% MoM. On the other hand, however, the factors at play that weighed on headline inflation seem likely to dissipate moving forward, meaning the champagne will need to remain on ice for the time being. This is not only reflected in the smaller base effects and the likely trough in energy disinflation, but also the lack of improvement in the Bank’s preferred measures of underlying inflation. In fact, the two core measures remain stuck within the 3.5-4% range that the BoC cited in its July monetary policy report after accelerating from 0.2% in May to 0.3% MoM in June, suggesting upside inflation pressures remain and should become more apparent in the headline measure once deflationary effects fade.

While today’s inflation report was always unlikely to tip the balance on the BoC’s next rate decision given the sheer amount of data still set to be released between now and September 6th, which includes one further inflation and jobs report, today’s data doesn’t even provide an early indication for markets to initially position themselves.

Headline inflation falls, but it will prove temporary

Headline inflation in Canada fell below the BoC’s year-end projection of 2.9% to 2.8% in June, bringing the average rate for the year down from 4.64% to 4.3% and towards the BoC’s full-year average projection of 3.7% YoY. However, the significant drop in the headline measure was largely due to favourable base effects, which brought the headline rate down by 0.653 percentage points, only partly offset by the 0.1pp increase last month. Looking ahead, the base effects are likely to moderate, with July’s reading subject to just a 0.14pp drag. Furthermore, much of the heavy lifting was done by energy deflation, with gas prices falling 21.6% YoY in June. As the effects of the energy shock in 2022 start to filter out of the measurement range, these effects should provide a less influential drag on the headline measure.

As such, we expect the BoC to not take too much comfort in the fact that headline inflation fell back to within its 1-3% tolerance band for the first time since May 2021, especially as alternate measures of inflation continue to track at levels well in excess of their 3% upper bound.

Some signs of positivity, but they were few and far between

Today’s data did however show other constructive signs for the BoC outside of the headline measures. Services inflation, for example, increased by just 0.1% MoM in June, marking a significant step down from its year-to-date pace of around 0.5%. Specifically, consumer discretionary items saw the pace of price growth cool, with restaurant prices increasing just 0.5%, down from 0.7% in May, and prices actually fall in recreation, education, and reading categories by 0.8%.

However, the cooling in core price pressures was narrow, evidenced by the uptick in the monthly pace of price increases in both of the BoC’s underlying core price gauges from 0.2% in May to 0.3% MoM in June. This saw the 3-month annualised measures, which the BoC places specific emphasis on as they smooth out monthly volatility, remain within the 3.5-4% range identified by the BoC in its last rate statement and MPR.

BoC officials won’t be pleased to a lack of progress in their underlying inflation measures

The market reaction was muted, with the main development being a shift in hiking expectations from September’s meeting to October 

Overall, today’s inflation report does little to tip the balance as it arrives at the beginning of a suite of economic releases ahead of the BoC’s September meeting and does little to suggest one way or another where inflation in Canada is heading. As such, the market reaction has been muted. Traders have partially trimmed the implied probability of a hike from the BoC in September from 25% to 20%, while simultaneously increasing bets that any further hike will occur at October’s meeting where another MPR is released. The odds of an October hike now sit at around 40%. In our view, this response in the Canadian OIS curve is a direct result of the mixed messages in today’s inflation report. Meanwhile, Canadian yields have tracked slightly lower, following their US counterparts and then some, while the loonie continues to weaken against the dollar, albeit to a limited extent.

With the BoC now undertaking the hard yards in its inflation battle, we expect the incoming economic data to print in a more mixed, similar to that of the US data that preceded the Fed’s pause in June. This not only makes every subsequent economic release between now and September’s decision more important in the eyes of both markets and policymakers, but also underlines our view that the extension in the USDCAD downtrend to the 1.30 handle will be slower going.




Simon Harvey, Head of FX Analysis


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