August Inflation Hotter Than Expected

Canada’s inflation rate accelerated more than expected for the second consecutive month, mainly driven by higher gasoline prices. This will not be a one-month wonder as gasoline prices rose further in September. 

The consumer price index increased 4.0% in August from one year ago, the fastest pace since April, after a 3.3% rise in July. That’s faster than the median estimate of 3.8% in a Bloomberg survey of economists. Monthly, the index rose 0.4%, double expectations. Excluding gasoline, the CPI rose 4.1% in August, matching the 4.1% increase in July.

Canadian inflation is no longer trending downward, presenting problems for the Bank of Canada. The BoC’s preferred 3-month core measure rose by a whole percentage point to 4.5%. The incoming data highlight the challenges in this phase of the inflation fight.

In addition to facing higher energy prices, Canadians paid more for rent and mortgage interest in August. Moderating the all-items CPI were declines in prices for travel-related services and a minor increase in food prices compared with the previous month.

The CPI was up 0.4% in August, following a 0.6% gain in July. The monthly slowdown was mainly driven by travel tours (-6.4%) and air transportation (-6.9%), as prices fell month over month following the peak of summer travel demand in July.

Even more troubling was the rise in core inflation, which filters out components with extreme price fluctuations and is followed closely by the central bank. The so-called trim and median core rates also rose, averaging 4% from an upwardly revised 3.75% last month, exceeding the 3.7% pace expected by economists. 

According to Bloomberg calculations, a three-month moving average of the measures that Governor Tiff Macklem has flagged as key to his team’s thinking rose by a full percentage point to an annualized pace of 4.49%.

Shelter prices were up 6.0% on a year-over-year basis in August after increasing 5.1% in July. The rent index led to faster shelter price growth, which rose 6.5% year over year nationally after a 5.5% gain in July. A higher interest rate environment may create barriers to homeownership and put upward pressure on the index. While rent prices accelerated in eight provinces, those with the fastest price growth were Newfoundland and Labrador (+8.4%), Alberta (+6.5%), Nova Scotia (+9.5%) and Manitoba (+6.1%).

The mortgage interest cost index also contributed to the acceleration in shelter prices, rising slightly faster in August (+30.9%) compared with July (+30.6%).

Although year-over-year price growth for groceries slowed in August, price levels remained elevated. On a year-over-year basis, prices for food purchased from stores rose 6.9% in August compared with an 8.5% increase in July.

Bottom Line

Roughly 50% of the prices in the CPI are growing more than 5%, which is still very concerning for the Bank of Canada. Market rates moved up meaningfully on the news. With the 5-year government bond yield well above 4%, fixed mortgage rates will increase this week. The odds of another 25 bps rate hike this fall have risen, but there is still another employment report and the September CPI release before the next announcement date on October 25th. 

Gasoline prices in September thus far have already risen to 10% above year-ago levels, so September inflation is likely also high. The additional problem for the Bank of Canada is that core inflation measures have also risen and will likely remain sticky on the high side. This has increased the odds of another rate hike this year. 

Mitigating the Bank’s inflation concerns is the slowdown in economic activity. Employment growth has slowed as the jobless rate rose to 5.5% and job vacancies fell. Excess demand has also fallen. Financial strains in the household, financial and business sectors are emerging as delinquency rates on non-mortgage debt have soared. A pause in BoC rate hikes is warranted, but if the economy starts to pick up again or core inflation continues to hold steady or rise, additional rate hikes cannot be ruled out.

Source: Dr. Sherry Cooper, Chief Economist, Dominion Lending Centres