The latest Consumer Price Index (CPI) data analysis from Capital Economics suggests a strong case for another interest rate cut by the Bank of Canada on July 24th. Despite some measures of monthly core price growth remaining above the rates consistent with the 2% inflation target, the overall inflation trend supports a rate reduction.
Downward Trend in Inflation Resumes
The June CPI data presented a welcome relief following the stronger-than-expected May release. Headline inflation eased to 2.7%, and monthly price gains in the all-items, CPI-trim, and CPI-median indices all softened. Although CPI-trim and CPI-median gains were marginally above the rates consistent with 2% inflation, the closely watched average three-month annualized rate increased to 2.9%, up from a low of 1.5% in March. This marginal increase is not expected to hinder the Bank of Canada’s decision to implement another rate cut next week.
Temporary Factors Influencing Inflation
The above-target monthly core price growth in May and June was driven by factors likely to prove temporary. For instance, the 0.6% month-over-month rise in food prices during these months was attributed to strong gains in several components, inconsistent with the softer producer price data. Additionally, the details of the June CPI release should alleviate concerns about the rise in services excluding housing inflation. The rebound in communication prices, after significant declines in 2023, was expected and does not indicate broader price pressures. Although annual services ex-housing inflation picked up, the monthly price momentum slowed in June, with prices rising by just 0.2%, following a 0.8% increase in May.
Easing Upside Inflation Risks
The Bank’s Business Outlook Survey (BOS) provided further evidence that upside risks to inflation from the labor market are easing. The share of firms experiencing labor shortages and their intensity fell sharply to historically low levels. Hiring intentions remained weak, increasing the risk that the unemployment rate, which hit 6.4% in June, will continue to rise. While most measures of wage growth remain elevated, they largely reflect past strength rather than current momentum. Forward-looking wage indicators in the Bank’s business surveys suggest that wage growth will slow significantly over the next six months.
Favorable Conditions for a Rate Cut
With labor market conditions easing and clearer signs of a downward path for shelter inflation, the Bank of Canada can be more confident that inflation will reach its 2% target within the forecast horizon. Markets are already pricing in a near 80% chance of another rate cut in July, focusing on changes in the tone of the Bank’s communications that may hint at the pace of further monetary easing. It is expected that the Bank will emphasize the direction of inflation rather than the latest data, highlighting that downside risks to the economy have grown while upside risks to inflation have moderated.
As we approach the July 24th meeting, all eyes will be on the Bank of Canada to see how it navigates these economic indicators and adjusts its monetary policy to foster a stable economic environment.
Sources: Capital Economics, Bank of Canada, Bloomberg, Refinitiv
