Bank of Canada Closely Watching Inflation as May’s Rate Drops to 3.4%

Annual Inflation Rate Drops, but Bank of Canada May Still Consider Rate Hike

The annual rate of inflation in Canada dropped sharply last month, but some economists argue that this slowdown might not be enough to deter the Bank of Canada from considering another interest rate hike in July. According to Statistics Canada, the annual inflation rate for May cooled by a full percentage point to 3.4 per cent. While most economists expected a significant drop in the headline inflation rate after reaching 4.4 per cent in April, the unexpected uptick in April was the first time the inflation rate had risen in 10 months. The drop in the annual inflation rate is largely attributed to the difference in energy price trends this year compared to last, as energy prices were down 12.4 per cent year-over-year in May.

Factors Influencing Inflation

The rising mortgage costs tied to the Bank of Canada’s higher interest rates continue to be the biggest contributor to the monthly Consumer Price Index (CPI) figures. The mortgage cost index rose 29.9 per cent annually, setting a new high for the largest increase on record for the third consecutive month. On the other hand, prices for cellular services dropped 8.8 per cent year-over-year, the biggest decline since April 2022. Additionally, furniture prices were down 2.9 per cent, and the price increase for passenger vehicles was the smallest since February 2021.

Another important factor affecting inflation is food prices. While some pressures at the grocery store are easing, other factors are cropping up to keep inflation sticky. Grocery price inflation remained elevated, rising 9.0 per cent year-over-year, nearly unchanged from April. Prices of edible fats and oils saw a 20.3 per cent jump, and costs were up 15 per cent for bakery products and 13.6 per cent higher for cereals. This can be attributed to a delay in Canada’s own growing season. The availability of affordable fresh vegetables, which usually come to market around this time of year, has been pushed back due to a “cold, wet spring.” As a result, more fruits and vegetables are still being imported from outside the country. The delayed growing seasons and import trends significantly affect food price inflation.

The Impact on Bank of Canada’s Decision

The Bank of Canada is closely monitoring the inflation trends and will use various indicators to determine whether another interest rate hike is necessary. While the decline in the annual inflation figures may not carry much weight, policymakers will pay closer attention to shorter-term monthly trends and the central bank’s preferred “core measures” of inflation. These core measures, which include CPI-median and CPI-trim, have declined modestly from April to May but remain elevated at 3.9 per cent and 3.8 per cent, respectively. While these metrics continue to run hotter than expected, they are below the consensus of economists’ expectations.

According to economists, every inflation metric remains far above the Bank of Canada’s two per cent inflation target. Therefore, the central bank may not be fully relieved by the recent decline in inflation. Further economic releases, such as the June jobs report and the Bank of Canada’s own business outlook survey, will provide more insight into whether enough has been done to bring inflation down to the target rate. Only significant signs of slowing in these economic indicators will lead the Bank of Canada to consider a pause in their tightening monetary policy. If policymakers believe that the previous rate hikes were insufficient, an additional 25 basis points is unlikely to satisfy the central bank’s concerns about returning inflation to the desired two per cent level.

Conclusion

The recent drop in Canada’s annual inflation rate has raised questions about the Bank of Canada’s upcoming rate decision in July. While the decline in inflation is notable, many believe that it may not be enough to prevent another interest rate hike. The central bank will closely monitor shorter-term trends, core measures of inflation, and upcoming economic indicators to determine the appropriate course of action. As inflation continues to be a critical factor influencing the Canadian economy, policymakers face the challenge of striking a balance between controlling inflationary pressures and supporting economic growth.