What to make of July’s hotter-than-expected Canadian inflation data?

Canada’s CPI topped consensus expectations in July, pushing up the annual inflation rate half a percentage point to 3.3%. Energy was a major driver of inflation last month and considering further increases in oil prices, don’t be surprised if inflation rises again in August, before resuming its downtrend. So, does the higher-than-expected CPI warrant more urgency from the Bank of Canada on the policy front?

Not really. For starters, much of the price pressures last month came from sources that have little to do with excess demand e.g., OPEC output curtailment (which pushed up oil and therefore gasoline prices), Alberta’s electricity price surge (fading impacts of earlier energy rebates), and soaring mortgage interest costs (courtesy of the central bank’s own rate hikes).

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To get a better idea of underlying price pressures, economists often look at core inflation measures (because they strip out volatile items like energy), and those are actually showing a moderation across the board. The average of the Bank of Canada’s two main core measures, namely CPI-trim and CPI-median, fell to 3.7% last month, the lowest since December 2021 (Figure 1). Other core measures, including the CPI excluding the eight most volatile items (3.2%), and CPI excluding food and energy (3.4%) also dropped to the lowest since 2021 — and if you strip out mortgage interest cost (which, as mentioned above, is more a function of BoC policy than excess demand), the latter measure is at a mere 1.9%. Simply put, underlying inflation is heading in the right direction.

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The Bank of Canada made clear in its summary of deliberations that it will assess inflation dynamics through four factors: the evolution of excess demand, inflation expectations, wage growth and corporate pricing behaviour. While the latter is hard to gauge in real time, we’re already seeing progress on each of the first three factors. Excess demand is already shrinking in both the product market (evidenced by a sharp deceleration of consumption growth — check out the September 1st release of Q2 GDP for confirmation) and the labour market (recall that the unemployment rate shot up to an 18-month high of 5.5% in July). Inflation expectations, while still high, are sinking fast according to the Bank of Canada’s last survey of consumer expectations. As for wage inflation, various measures monitored by the central bank suggest it peaked in Q4 last year and odds are that it will continue to moderate over the rest of 2023 thanks to the apparent easing in labour demand, evidenced by the decline in job vacancy rates. All this to say that while another rate hike is possible in September, the overnight rate, currently at 5.00%, is very close to peaking.