Canadian inflation still isn’t under control, with July’s report showing a strong uptick in headline inflation and continued strength in underlying core measures.
Despite expectations for a slight uptick to 3.0%, the headline inflation rate jumped 0.5 percentage points to 3.3% year-on-year, fuelled by a hefty 0.6% monthly increase in overall prices and energy base effects. Excluding food and energy, prices rose by 0.5% from June to July after a flat reading in the previous report, while the Bank of Canada’s preferred measures of core inflation—the 3-month annualised measures of core-median and core-trim—eased slightly to 3.6% and 3.4% after April’s strong readings dropped out of the averages. With the breadth of inflation pressures picking up from last month, and signs of strong price growth in discretionary components, the risk of another hike from the Bank of Canada has risen.
Markets are now discounting a 30% chance of a hike in September, up from 23% before the report, but see an 85% chance of an additional policy adjustment between now and January.
While we had warned for months that by mid-year, base effects would no longer create the illusion that inflation was falling as sharply as it seemed, we did not anticipate that the monthly impulse would still be running this hot this far into the year. After a brief respite last month, services inflation returned with a vengeance, rising by a full 1.0% in July alone. Shelter also continued to show strength, with rents (+0.4%), mortgage costs (+2.0%) and utilities (+2.3%) all rising quickly on a month-over-month basis. The report didn’t only have bad news, with prices for clothes (-1.2%), furniture (-1.8%), and household equipment (-0.7%) all falling outright in July, and healthcare costs (+0.1%) keeping in line with the inflation target.
But for the most part, prices are still going up too quickly for comfort and could translate to annualised core inflation pressures in the 4% to 4.5% range once again this year if not brought under control.
The real disconnect is the continued strength of discretionary spending-sensitive components. While the high cost of living is top of mind in Canada, as repeatedly shown by opinion polling, today’s report highlights that Canadians are still spending, despite the difficulties that high inflation has caused to their personal finances. Two key examples highlighting this are that restaurant prices rose by 0.6% in July, while recreation surged by 1.3%.
For the Bank of Canada, today’s CPI data will be a source of headaches all around the Governing Council.
The report probably wasn’t hot enough to cause an immediate restart of policy tightening, but it definitely wasn’t cool enough to confirm that price growth is back under control. Granted, inflation in Canada is still not as elevated as seen in parts of Europe for example, and BoC projections had expected the inflation would stay around 3% for the next year before eventually returning to the 2% target by the mid-2025.
But with inflation continuing to look sticky, policymakers will be thinking hard about the need for further policy tightening. This dynamic is certainly playing out in markets, where yields on Canadian government bonds have ticked up, and market implied expectations are now close to fully pricing another hike from the BoC.
Although the read through for FX markets is muddled by the simultaneous release of retail sales numbers south of the border, the increased odds of a further rate hike have seen the loonie picking up support against the dollar. USDCAD fell around 0.2pp on the release, before subsequently paring back much of the move lower.
Canadian inflation remains elevated across key measures, raising the odds of another hike
Jay Zhao-Murray, FX Market Analyst