Bank of Canada Evaluating Next Steps as Inflation Rate Plunges to 3.4% in May

The Bank of Canada’s Next Steps as Inflation Rate Plunges in May

A Sharp Drop in Inflation Rate

According to Statistics Canada, the annual inflation rate for May in Canada dropped by a full percentage point to 3.4 per cent. This comes as a surprise to most economists who had anticipated a more modest drop to 3.6 per cent. The headline inflation rate had reached 4.4 per cent in April, marking the first time in 10 months that the rate had risen. The significant decrease in May‘s inflation rate can be attributed to the difference in energy price trends compared to the previous year. Energy prices were down 12.4 per cent year-over-year in May, significantly impacting the overall inflation rate.

Impact of Mortgage Costs and Cellular Services

Rising mortgage costs, driven by the Bank of Canada’s higher interest rates, were the biggest contributor to the monthly Consumer Price Index (CPI) figures. The mortgage cost index rose 29.9 per cent annually, setting a new record for the largest increase. On the other hand, prices for cellular services dropped 8.8 per cent year-over-year, marking the largest decline since April 2022. Additionally, furniture prices decreased by 2.9 per cent, while the price increase for passenger vehicles was the smallest since February 2021.

Delayed Growing Seasons Impact Food Inflation

While some inflation pressures at grocery stores are easing, others—such as delayed growing seasons—are causing food inflation to remain sticky. Grocery price inflation remained elevated in May, rising 9.0 per cent year-over-year. The prices of edible fats and oils saw a 20.3 per cent jump, while bakery products and cereals witnessed increases of 15 per cent and 13.6 per cent, respectively. Due to a cold and wet spring, there has been a delay in the availability of locally grown produce, leading to increased imports of fruits and vegetables from outside the country.

Competition Bureau’s Investigation into Grocery Sector Concentration

On the same day that the inflation report was released, the Competition Bureau in Canada published the results of its probe into concentration in the grocery sector. The investigation revealed a lack of competition, which has been driving prices higher. This finding aligns with concerns raised by consumers about the increasing costs of groceries.

Bank of Canada’s Decision-Making

The question now is whether the Bank of Canada will consider the drop in the inflation rate as a significant enough indication to deter another rate hike in July. According to Nathan Janzen, assistant chief economist at RBC, the bank won’t focus on the decline in the annual figures but instead look at the monthly trends and the central bank’s preferred “core measures” of inflation. These measures, such as the CPI-median and CPI-trim, have declined modestly but remain elevated at 3.9 per cent and 3.8 per cent, respectively.

Expert Opinions on the Bank of Canada’s Next Move

CIBC senior economist Andrew Grantham suggests that the central bank might consider waiting longer than July before implementing another interest rate hike, given that the metrics for inflation continue to remain above the target of two per cent. Benjamin Reitzes, managing director of Canadian rates and macro strategist at BMO, states that core inflation remains sticky and has yet to show signs of a durable slowdown. However, Randall Bartlett, senior director of Canadian Economics, maintains the view that the Bank of Canada will proceed with another 25 basis points rate hike in July, while remaining open to further tightening if the data fails to support a slowdown in inflation.

Looking Ahead

While the inflation rate has dropped in May, it is important to consider that inflation tends to be a lagging indicator, reflecting past economic conditions. The Bank of Canada will monitor economic releases, such as the June jobs report and its own business outlook survey, to assess whether inflation is on track to reach the target of two per cent. If there are significant signs of slowing in these indicators, the central bank may pause its rate hikes. However, if policymakers believe that previous rate hikes were insufficient, an additional 25 basis points increment may not satisfy their concerns about returning inflation to the desired level.