News & analysis

On a non-seasonally adjusted basis, headline inflation in Canada grew by 0.56% month-on-month in May, beating expectations by six tenths of a percent.

With the headline measure having now increased an average 0.56% over the past three months, the annual rate of inflation has also increased, rising from 2.69% to 2.87%, its joint highest level this year. Moreover, for the first time since December 2023, the Bank of Canada’s preferred measures of core inflation have also increased. The trimmed measure of core inflation increased 0.09pp to 2.91%, while core-median increased 0.14pp to 2.82% YoY. Core inflation pressures also accelerated on a sequential basis, with the average 3-month annualised pace of core price growth accelerating from 1.64% to 2.52%. While on the surface the increase in the main inflation aggregates has introduced some uncertainty over the view that the BoC will be one of only a few G10 central banks to conduct a sequence of rate cuts this year, the details of the report are less damning. Most of the increase in inflation stemmed from seasonal and transitory factors, meaning the latest bout of inflation doesn’t signal a departure from the previous disinflationary trend.

As a result, we continue to look for the BoC to cut rates for a second time on July 24th, with two more rate cuts likely this year.

Acceleration in headline prices was largely attributable to services, driven primarily by cellular services, travel tours, rent and air transportation. Statistics Canada noted that deflation in cellular services was much slower in May (-19.4% YoY) than in April (-26.6% YoY), driven primarily by base effects as service costs were cut by 7.8% MoM back in May 2023. This one-off effect contributed 0.12pp to headline inflation on the month. Additionally, higher prices for travel tours (+6.9% YoY) and air transportation (4.5%) led overall transportation inflation to rise 0.3pp to 3.45%, adding a further 0.06pp to headline inflation as its increase was partly offset by its weighting in the basket declining 0.16pp to 16.78%. Outside of services, shelter and food provided the largest net impulse to headline inflation at 0.04pp and 0.01pp respectively. This partly reflected their increased weightings within the CPI basket, where food’s share increased by 0.59pp to 16.72% and shelter by 0.35pp to 28.57%. With respect to shelter, the stronger weighting masks underlying disinflation, where the pace of price growth dropped from 0.5% to 0.39% MoM.

That said, food prices grew the most since January 2023 at 1.1% MoM. While this sounds concerning, we note that it is seasonally typical for food prices to climb this time of the year.

On the contrary, products that better display underlying cyclical pressures within the Canadian economy, such as health & personal care and clothing & footwear, exhibited disinflation on a monthly basis. The pace of clothing inflation cooled further, from 2.84% MoM in March to flat in May, while price growth in health and personal care moderated from 1.15% to 0.8%. Moreover, while the latest data shows an uptick in the pace of inflation across all major aggregates, it is worth noting that they all remain comfortably within the BoC’s 1-3% target range.

So although the data introduces a risk to our base case of back-to-back cuts from the BoC in July, we remain convinced that these one-off effects will reverse in June’s inflation report released just a week before the BoC next meets.

In conjunction with data showing further slack emerging within the labour market and the Canadian economy continuing to operate below potential, this should be sufficient for the BoC to confidently cut rates one again next month. Our view has been shared by the FX community. After initially spiking higher, the Canadian dollar failed to consolidate its gains, even as Canadian yields continued to trade higher. This is especially notable in the context of overall market positioning, where shorts in CAD stand out as the most saturated within G10 FX and are thus vulnerable to a sharp unwind. Despite today’s data, we continue to hold a short CAD bias heading into Friday’s growth data, which has failed to live up to expectations more often than not.



Simon Harvey, Head of FX Analysis


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