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Canada’s annual inflation rate fell for a second consecutive month in August as gasoline and other products dropped, offering some hope that the Bank of Canada’s campaign to restrain price growth through much tighter lending conditions is having its intended effect.

The Consumer Price Index (CPI) rose 7 per cent in August from a year earlier, lower than the consensus expectation of 7.3 per cent. Inflation has slowed from 7.6 per cent in July and 8.1 per cent in June, a near four-decade high.

On a monthly basis, the CPI fell 0.3 per cent in August, which again was weaker than what analysts expected. Gasoline prices, which fell 9.6 per cent in August from July, were a key driver of lower inflation. But progress was seen elsewhere in getting prices down. the average of the Bank of Canada’s core measures of annual inflation – which strip out volatile aspects of CPI and give a better sense of underlying inflation trends – fell to 5.2 per cent in August from 5.4 per cent in July.

Short-term Canadian bond yields fell in the aftermath of the report, even as equivalent U.S. bond yields rose, with the 2-year government bond yield falling as low as 3.732%, down more than 3 basis points on the day. The Canadian dollar weakened against the greenback, trading at midday down about half a cent to just under 75 cents US.

Money markets now see an 87 per cent probability of a 50-basis-point interest rate hike by the Bank of Canada in October, after having fully priced in a move of that magnitude before the data. Markets are pricing in good odds of a further quarter point hike by year’s end, but their positioning suggests that may be the last one in this tightening cycle. The central bank has already raised rates by 300 basis points in just six months to 3.25%, a 14-year high.

Here are how economists are reacting to today’s data:

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Benjamin Reitzes, Managing Director, Cdn Rates & Macro Strategist, BMO Capital Markets:

This is about as good of an inflation report as we can hope for, especially after the strong U.S. figures out last week. The slowdown in the headline and all three core inflation metrics is a clear positive. Unfortunately, inflation remains far too high, and the breadth of price increases hasn’t backed off much, if at all. Nonetheless, the path to tamer inflation is going to be long and winding, and this is a step in that direction. While there’s still plenty of data to go before the next Bank of Canada policy decision, today’s number will, for now, limit how much further tightening the market prices.

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Andrew Grantham, CIBC economist:

Inflation likely hasn’t slowed far enough, or for long enough, to convince the Bank of Canada that further interest rate hikes aren’t necessary. Because of that, we still see a peak of 3.75% for the overnight rate later this year. However, today’s inflation readings, as well as other data highlighting a slowing Canadian economy, support the view that interest rates here should peak below what the Federal Reserve will need to do in the US in order to get inflation back to a 2% target.

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Alexandra Ducharme / Kyle Dahms of National Bank:

For the next few months, there are reasons to be optimistic about a moderation in inflation due to weakness on the goods side. First, the decline in the price of oil and consequently gasoline (which continued in September) is good news that usually translates with a lag into disinflation for other components, notably because of more favorable transportation costs. Second, supply chain issues are easing globally. Third, there was also good news on services inflation, which posted the smallest monthly increase in nine months (0.1%), an indicator that the Bank of Canada is monitoring closely. Overall, with a tangible economic slowdown expected in the second half of 2022, our forecast of CPI inflation below 5% in Q1 2023 remains on track.

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Leslie Preston, Managing Director & Senior Economist, TD Economics:

A journey of a thousand miles starts with a single step. Canadian inflation took a single step in the right direction in August, but it still has a long way to go. The Bank of Canada (BoC) core measures of inflation remain more than 2 pps from the target range of 1-3%. The BoC has hiked interest rates 300 basis points so far this year, and the impact of that is starting to be felt in the economy. Even still, we expect more slowing in demand, which should help bring down inflation along with it.

Still, there is a long journey ahead, and we expect the BoC to continue hiking its policy rate at the end of October, and take the policy rate to 4% by the end of the year.

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Derek Holt, Vice-President & Head of Capital Markets Economics, Scotiabank:

What the readings do is to take out pricing that was starting to lean toward something bigger than a 50bps move at the October 26th decision and bring it back to our call for 50. Some of that may also be wrong-footed positioning perhaps gone too far.

Still, there is a lot of ground to be covered between now and that meeting including domestic and external data, the Fed, and market developments. Another inflation print arrives one week before the October decision. Today’s number is probably best positioned as just a marker on the highway toward the next decision in about five weeks time. There is less acute pressure on the BoC to hike by more than 50 at the next meeting than is facing the Fed tomorrow since the BoC already has a 75bps spread over the Fed into the FOMC.

Further, if the BoC comes through on a pause signal at the October meeting it could a) be vulnerable to the implications of a Fed that’s likely not prepared to go there which could test the limits of BoC independence from the Fed, and b) could ease financial conditions relative to market pricing at a curious time that could raise doubts about the BoC’s commitment to fighting inflation to the end after it blew it throughout 2021 and early 2022.

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Stephen Brown, Senior Canada Economist, Capital Economics:

The larger-than-expected falls in headline and core inflation in August lend some support to our forecast that the Bank of Canada will drop down to a 25 basis point hike in October, particularly with the labour market also weakening in recent months.

Headline inflation is admittedly still far too high at 7.0%, but that was at least lower than the 7.3% consensus forecast. Moreover, in contrast to our expectation that core inflation would be broadly unchanged, all three of the Bank’s measures declined, with CPI-common falling from an upwardly revised 6.0% in July to 5.7%, while CPI-trim slowed from 5.4% to 5.2% and CPI-median edged down to 4.8%, from 4.9%. The contrast compared to the strength of underlying prices in July is largely because the rises in travel services prices that month were not repeated in August, with recreation, education & reading prices instead falling by 0.1% m/m in seasonally adjusted terms. Shelter prices also edged down on the month, for the first time since January 2021, as the impact of falling house prices more than offset higher mortgage rates. Meanwhile, the 1.1% m/m fall in transportation prices was mainly due to lower gasoline prices, but Stats Can also noted that used vehicle prices started to decline.

The headline rate is likely to slow again in September and we now expect inflation to average 7.1% this quarter, which would be much better than the Bank’s forecast from July that it would average 8.0%. The risks to our forecast that the Bank will drop down to a 25 bp hike next month are still tilted to the upside but, with the leading indicators pointing to a further improvement in core inflation and the labour market weakening in recent months, we are doubtful that the Bank will hike its policy rate to more than 4%, from the current 3.25%, as markets are currently pricing in.