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July inflation eases in Canada

Inflation eased in July…kind of. What it means for the BoC’s next rate hike

Led by a drop in gas prices, Canada’s annual inflation rate eased to 7.6% in July, according to data released by Statistics Canada.

That follows a 40-year-high of 8.1% in June, which some observers believe may mark the peak in inflation. That would be welcome news for the Bank of Canada, but still not enough to keep it from hiking interest rates further when its Governing Council meets on September 7.

That’s particularly true given that the Bank’s preferred measure of core inflation continued to rise in July, reaching an annual rate of 5.3%, its highest level in over 32 years.

Highlights of July’s inflation data

Headline inflation was kept under control thanks largely to a sharp decline in gas prices, which were down 9.2% compared to June. However, they still remain 35.6% above year-ago levels, TD economist Leslie Preston noted in a research report.

Food prices, on the other hand, were up 9.9% compared to a year ago, up from 9.4% in June.

Shelter costs decelerated marginally, led by an easing of homeowners’ replacement cost, which is related to the cost of new homes. That was up 9.1% in July compared to 10% in June.

The “other owned accommodation expenses” basket, which includes real estate commissions, was up 9.7% (vs. 12.2% in June and a peak of 17.2% in April) as home prices continue to decline.

Meanwhile, the mortgage interest cost index showed its first increase since September 2020, rising 1.7% in July vs. a decline of 0.6% in June.

What it all means for the Bank of Canada

While the slight moderation in headline inflation is encouraging, observers say the rise in core inflation still poses a challenge for the Bank of Canada, which is expected to raise interest rates again next month.

“We expect the BoC to continue hiking its policy rate at an aggressive clip at its next announcement in three weeks,” said TD Bank’s Leslie Preston. “We currently expect a 50 basis point hike, but it appears market odds tipped a bit more towards a larger 75 basis point move, likely focusing on the lack of progress in core inflation measures.”

Scotiabank’s Derek Holt wrote that a 75-bps hike is more likely, given the continued rise in core measures of inflation.

“The Bank of Canada won’t care about the headline softening. They’ll be more concerned about ongoing upward pressure upon core measures,” he wrote. “The data lends itself to a 75bps move on September 7th that would bring the policy rate closer to being in very mildly restrictive territory given estimates of the neutral policy rate range of 2–3%.”

Notably, Statistics Canada made significant upward revisions dating back to May 2021 to its “common component CPI,” one of the three preferred measures of core inflation. It was revised up to 5.3% in June from 4.6%.

Overall, “This report is clearly a step in the right direction, but the journey is many miles,” noted BMO’s Douglas Porter.

“Yes, we may finally be past the peak of inflation—provided oil prices don’t run wild again—but it is likely to remain very sticky at close to 8% through the second half of this year before truly breaking lower in 2023,” he wrote. “So, while inflation is coming in a tad below what the Bank of Canada expected in their latest forecast…we still look for a minimum of a 50-bps hike at their next meeting in early September.”