A dip in inflation may not be enough to stop the BoC from raising rates next month

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OTTAWA – Forecasters expect the Bank of Canada to push ahead with another rate hike in July, even as they expect the annual rate of inflation to slow significantly.

Statistics Canada is due to release its May Consumer Price Index report on Wednesday, providing the latest inflation reading ahead of the BoC’s interest rate decision on July 12.

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“I think this will probably be a fairly optimistic release on inflation, in the sense that we expect inflation to fall below four percent,” said James Orlando, director of economics at TD.

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On the food inflation front, Orlando is also hopeful that price increases will slow more meaningfully.

We haven’t seen the same slowdown in food prices as the US on a monthly basis recently. And that’s something you’re kind of hoping will start to show up in Canada as well,” he said.

In April, grocery prices were 9.7 percent higher than they were a year ago.

The inflation rate rose slightly to 4.4 percent in April, marking the first increase since last summer. The report raised the Bank of Canada’s concern that progress in the inflation rate has slowed, despite sharp increases in interest rates since March 2022.

But next week’s release is expected to show the inflation rate falling again, with BMO forecasting that Canada’s inflation rate fell a full percentage point to 3.4 percent in May.

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“A big part of this (the drop) is just because rates went up so much a year ago,” said Benjamin Ritzes, managing director of Canadian interest rates and macro strategist at BMO.

Economists had widely expected that the annual rate of inflation would fall sharply this year due to base-year effects — which indicate the effect of price movements from a year ago on account of the year-on-year inflation rate.

A drop in inflation to around three percent is likely to make Canadians feel better about the inflation outlook and potentially help with future inflation expectations, Ritzes said, but it does not completely eliminate the BoC’s concerns.

Most forecasters, including Orlando and Ritz, expect the Bank of Canada to raise interest rates again in July, doubling the hike in June. This is because they do not expect the BoC’s main concerns – core inflation and a strong economy – to be mitigated.

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“The reason the Bank of Canada decided to hike rates so aggressively at their last meeting, and why they are likely to hike rates again in July is because the Canadian consumer continues to spend,” he said.

Earlier this month, the Bank of Canada announced a quarter-percentage-point hike that took the main interest rate to 4.75 percent – its highest level since 2001.

The decision to raise interest rates again, despite announcing a pause earlier in the year, was prompted by a string of hot economic data that stoked fears at the central bank that the journey back to 2 percent inflation was taking longer than expected in the past year. the previous.

Economic growth in the first three months of the year was higher than expected, driven in part by strong consumer spending, which rose 5.8 percent.

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“While Canadians continue to spend, price pressures continue to build,” Orlando said. “That’s why I think they’ll probably raise in July.”

The Bank of Canada has also been keeping a close eye on core inflation, which removes volatility from this measure. Reitzes expects core inflation actually accelerated last month, and that was more bad news for the central bank.

The Bank of Canada has not given any hints to the financial markets as to which way it is swinging. Instead, it was indicated that it plans to base its July decision on income data.

But with just one month of data to work with, Reitzes says it will take poor results on all fronts to convince the BoC not to raise interest rates.

“Unless you get uniformly weak data, it seems very likely that they will have to push interest rates higher again,” he said.

This report by The Canadian Press was first published on June 23, 2023.

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