Another interest rate cut by the Bank of Canada next month is now less likely following the unexpected rise in May inflation, according to both money market traders and economists.
The annual inflation rate rose to 2.9 per cent in May while key measures of core inflation edged up for the first time in five months, Statistics Canada reported Tuesday. It was a significant miss versus Street expectations for an inflation rate of 2.6 per cent - which would have represented a decline from April’s reading of 2.7 per cent.
Markets immediately responded by sending the Canadian dollar higher, while domestic bond yields spiked as traders scaled back bets on the odds of another interest rate cut in July.
According to LSEG data (formerly Eikon), swaps markets are putting 45 per cent odds now on a second rate cut by the Bank of Canada on July 24. They stood at 65 per cent prior to the 830 am ET inflation report. Swaps are pricing in about 72 per cent odds of a rate cut materializing at the September Bank of Canada meeting (there is no meeting in August).
Some 50 basis points of additional easing is now priced into the market by the end of this year, which is modestly less than before this morning’s inflation data.
The loonie rose about two-tenths of a cent, to 73.29 cents US, but later retraced a lot of that advance. Both the government of Canada two-year and five-year bond yields jumped 10 basis points, and largely held there throughout the morning. While those are quite large daily moves in the bond market, they only bring those yields back to where they were earlier this month, with the five year now at 3.464 per cent.
This was, however, a large enough move in bond yields to put pressure on interest rate sensitive stocks on the Toronto Stock Exchange. Both utility and real estate sectors were down close to 1 per cent in morning trade.
Here’s how implied probabilities of future interest rate moves stand in swaps markets, according to data from LSEG as of 846 am ET. The Bank of Canada overnight rate is 4.75 per cent. While the bank moves in quarter point increments, credit market implied rates fluctuate more fluidly and are constantly changing. Columns to the right are percentage probabilities of future rate moves.
And here’s how markets were pricing in monetary policy changes just prior to the data being released:
Here’s how economists and market strategists are reacting in written commentaries following the data:
David Rosenberg, economist and founder of Rosenberg Research
There is another CPI report yet to come (on July 16th) before that meeting, and we still feel that the Bank should cut again given the fact that the economy is in excess supply, which means the pressures on inflation going forward will be down, not up. Today’s data just go to show that nothing moves in a perfectly straight line.
That said, there were some encouraging signposts. The common core inflation rate slowed for the ninth month in a row — to +2.4% YoY from +2.6% in April, +5.2% a year ago, and the lowest since April 2021. This is a key metric because this measure of inflation screens out the noise across components in these monthly price reports.
The CPIX measure, which excludes the 8 most volatile components, did rise an outsized +0.3% MoM, but to be frank, this comes on the heels of five flattish reports and the YoY trend at +1.8% (was +1.7% in April) compares to +3.6% a year ago and +6.1% two years back. In other words, the fundamental downward trendline remains intact.
Matthieu Arseneau and Alexandra Ducharme, economists at National Bank Financial
Does this morning’s data suggest that the Bank of Canada acted prematurely in cutting rates in June? We don’t think so. We expected there to be ups and downs due to the monthly volatility of the data. While May was definitely disappointing, the recent trend seems to us to be much more in line with the economic context. On a 6-month horizon, both the CPI-trim (2.5%) and the CPI-median (2.3%) are rising at annualized rates just above the Bank of Canada’s target with only 24 categories running above target. This slight overshoot would be worrisome if the economy were showing strength, but it’s quite the opposite at the moment. GDP per capita continued to fall in the first quarter and should continue to do so, given high inventories and the ongoing interest payment shock. Unemployment is already rising sharply and we expect it to rise further. The decline in corporate profits in the first quarter could be a harbinger of further deterioration. Businesses claim they are no longer experiencing labor shortages and may have too many workers relative to economic activity, as evidenced by the declining trend in output per worker since 2022. Given the current restrictive monetary policy and the lag in the transmission, we continue to believe that the Canadian economy needs further rate cuts.
Olivia Cross, North America economist, Capital Economics
July cut on shaky ground .... The stronger monthly gains in the Bank of Canada’s preferred core price measures will give the Bank some cause for concern after starting its loosening cycle in June. However, with some of that strength due to factors that are likely to be one-offs, and given there is another CPI report before the late July meeting, for now we are sticking with our view that the Bank will cut again next month.
The larger-than-expected 0.3% m/m seasonally adjusted rise in the headline CPI brought the annual rate back up to 2.9%. There were upside surprises in a number of components, although some are unlikely to be repeated, such as the 2.4% jump in travel services, 0.5% rebound in food prices and the larger 0.9% m/m jump in rents. The good news was that, despite the latter, shelter prices rose by a softer 0.4% m/m, thanks to the softest gain in mortgage interest costs since the Bank’s earlier hiking cycle began. However, with the new CPI weights incorporated in this release increasing the importance of shelter prices, even that milder price overall gain still had an upward effect on the monthly increase in overall prices.
The bad news was that CPI-trim and CPI-median each rose by 0.3% m/m and the average monthly gain in April was revised up to 0.2%, a step up from the 0.1% gains seen over the first three months of the year. All that means the three-month annualised rate rose back up to 2.5%. That is a step backward and increases the chance of the Bank pausing at its July meeting, but there are several more key data releases before then that could sway the Bank’s thinking.
Jules Boudreau, senior economist, Mackenzie Investments
Today’s inflation data shows that Canada’s path to 2% will be a bumpy road, but doesn’t rule out multiple rate cuts in the rest of 2024. Canadian inflation exceeded the average economist’s forecast for the first time in 2024, interrupting a string of comforting CPI prints for the Bank of Canada. ...
Prices accelerated across the board, with services prices contributing most to the uptick in inflation. Most notably, rents surged in May, rising 10% (annualized) from April 2024 to May 2024. While rents are hard to measure precisely from one month to the other, and one data point isn’t a trend, this uptick is a headache for the Bank of Canada. Rent is salient, politically sensitive, and has a massive weight in the consumer basket.
This CPI report is not a death knell for a July rate cut. The Bank will see one additional CPI report, and a pivotal jobs report before decision time comes. Over the course of 2024, the balance of risk has clearly turned from inflation to growth. Cutting rates at a steady pace is necessary to jumpstart an ailing Canadian economy that is underperforming all its global peers. Zooming out, a sustained bounce in inflation is very unlikely, given the sluggish state of the economy and the disinflationary trend around the world. The Bank of Canada won’t miss the forest for the trees. Multiple rate cuts are still on the table for the rest of 2024.
Katherine Judge, senior economist with CIBC World Markets
Overall, today’s inflation print has a number of mixed elements, but the headline reading was clearly not good. It does, however, come after four stellar readings to start the year, suggesting the roughly 1.6% three-month annualized pace we saw in recent months was unsustainable. On the surface, it is still difficult to see much of today’s increase as demand-driven but after a period of high inflation, and inflation expectations of households and business not fully back to normal, central bankers worry about how prolonged periods of inflation above target can get expectations stuck above target and make the last mile difficult. ...There is one more CPI print before the July BoC meeting and a plethora of other economic data. While this print clearly tilts the risks towards fewer cuts than the three more that we have penciled in for the year, policymakers are in data dependent mode and will need to see a wider set of data in order to determine if the acceleration in CPI in May was an anomaly or the start of a trend.
Royce Mendes, managing director and head of macro strategy, Desjardins Securities
The past few months had seen price pressures cooling more than expected, so today’s release might simply represent some give back. Our base case forecast continues to look for another rate cut in July, but upcoming data releases on employment and inflation will take on even more importance to make that a reality. The next Bank of Canada rate decision isn’t until the end of next month, so there’s ample time for the data to turn back.
Douglas Porter, chief economist, BMO Capital Markets
This is the first time in 2024 that Canadian inflation has landed decisively on the high side of consensus, and is clearly a step in the wrong direction.
The upside surprises were in food and services. While food is not the major inflation driver of a year ago, both groceries and restaurant costs took a big step up in the month, lifting overall food prices 0.5% m/m in s.a. terms, and nudging up the yearly rate to 2.4%. For services, the recreation category was boosted by big increases in travel tours (10.4%) and hotels (16.0%), which both saw larger than normal May increases (especially tours). Meanwhile, busily churning away, rent rose another meaty 0.9%, lifting the yearly increase to a towering 8.9% y/y pace—the second largest contributor to annual inflation. If there was any good news here, it was that single largest inflation driver—mortgage interest costs—relaxed a bit, rising “just” 0.8% m/m, but mild enough to cut the annual pace to 23.3% (it peaked above 30% last year). Excluding these heavy-duty shelter components, inflation is rising a mild 1.5% y/y, although that’s up from 1.2% last month.
No bones about it, this is not what the Bank of Canada wanted to see at this point, and clearly shaves the odds of a follow-up July rate cut. However, it doesn’t rule out such a move, as we will see one more CPI (next one is July 16, eight days before the July 24 rate decision). With inflation back on a bumpy path, the outlook for BoC moves is similarly bumpy. For now, our official call remains that the next BoC rate cut will be in September, and this report does nothing to move that needle.
Derek Holt, vice-president and head of capital markets economics
Did haste make waste at the Bank of Canada? One strong inflation report on its own doesn’t toss up in the air what may be the appropriate path going forward. Having said that, the combination of choosing to rush a cut in June against his prior guidance, Governor Macklem’s rather strident claim that the BoC is “not close to those limits” of how much the policy rate spread can undershoot the US, and his total indifference to CAD weakness seem to have been missteps given the clear signal that Canada is not out of the woods on inflation risk yet. ...
Key will be the next inflation report on July 16th.... I would not have cut in June if I were Macklem. I listened to him when he said he wanted “months” of additional evidence. I view that cut as policy error because it violated forward guidance and prematurely reacted to only four months of soft core inflation after blowing it for four years and with the economy outperforming the BoC’s expectations over 2024H1 compared to their gloomy bias at the start of the year. Wages, productivity, fiscal stimulus, more coming fiscal stimulus, housing shortages, excessive immigration, and the no-rush FOMC are among the sources of inflation risk and reasons for continued caution as opposed to guiding several cuts.
The prime reason we are forecasting three more cuts over the duration of this year—conditional upon the data—is the BoC’s reaction function—and specifically Governor Macklem’s. He clearly has a bias to cut and keep cutting by guiding that it’s reasonable to expect a series. There is a strong case for staying on hold going forward and having stayed on hold last month.
We’re all dealing with enormous uncertainty about the path forward and in that context reliable communications and forward guidance are important. In their absence, markets will be more unstable and the implications for confidence in the economy are damaging.
Tu Nguyen, economist with assurance, tax & consultancy firm RSM Canada
Even with a slight uptick in inflation in May, a July rate cut is still in the cards if next month’s core inflation measures show favourably. Although services inflation remains a concern due to elevated wage growth, this trend is unlikely to persist through the year as consumer spending wanes and the labour market rebalances. Groceries inflation rose but remains the lowest in years excluding last month’s figure.
Bank of Canada Governor Macklem was decidedly dovish in his speech on Monday by suggesting that the economy can add jobs without pushing up inflation, and one sure way to stimulate hiring is to cut rates. Though a July rate cut would widen the policy rate differential with the United States, the effect will be temporary since US inflation is also expected to fall, possibly sharply, later this year. ... Even if the Bank of Canada announced another rate cut in July, bringing the policy rate to 4.5%, the policy rate will still be sufficiently restrictive given the growth and inflation outlook. Therefore, one month of accelerated inflation will give the Bank a pause but should not take rate cuts off the table.
James Orlando, director and senior economist, TD Economics
Today’s report won’t instill any added confidence for the Bank of Canada. The central bank cut interest rates in early-June because it gained sufficient conviction that it had inflation under control. Just yesterday, Governor Macklem said in a speech, “since January, inflation has been below 3%, and our measures of underlying inflation have eased steadily. This has increased our confidence that inflation will continue to move closer to the 2% target this year.” Now, one bad inflation print doesn’t make a trend, and inflation remained below 3%. But it does speak to the unevenness of the path back to 2%. For this reason, we think the BoC will likely pause at its July meeting, before cutting rates again in September.
Charles St-Arnaud, chief economist, Alberta Central credit union
This is the fourth consecutive month that the momentum in the BoC’s core measure of inflation is at or below 2.5%. The inflation momentum suggests that the underlying inflation dynamic remains consistent with the BoC’s target.
Today’s report will be a disappointment for the Bank of Canada. While headline and core inflation remained within the BoC’s inflation target band (i.e. below 3%), rising momentum in many components and an increase in the breadth of the inflationary pressures are likely to be considered a setback. Overall, the lack of progress on inflation in May reduces the likelihood that the BoC will cut in July. However, with another CPI release before the July decision, the door is not be completely closed to a cut if the May surprise proves to be temporary.
Nathan Janzen, assistant chief economist, Royal Bank of Canada
The acceleration in May CPI growth is the first significant upside surprise of 2024. The closely-watched 3 month growth rates for the median and trim measures ticked back above the 2% inflation target, but year-to-date (5-month average) increases are still essentially bang-on 2%. The BoC is highly data dependent, and the upside surprise in May CPI growth will put more focus on the June CPI numbers to be released ahead of the next policy rate decision in July. But softening per-capita GDP and rising unemployment also increase the odds that price growth will continue to broadly slow.
Bryan Yu, Central 1 chief economist
For the Bank of Canada, this was an unhelpful reading in its desire to reduce rates and view that inflation is easing. That said, this represents only one month of data and much of the inflation uptick was specific to Ontario rent, and several segments. Shelter challenges as we note will not be cured by high rates, and excluding shelter, inflation was still a mild 1.5 per cent. The path to target inflation was never going to be smooth and the latest numbers cuts the likelihood of a July rate cut. That said, with several key data points to come in before the July decision, including GDP, labour markets and another CPI reading we expect momentum to slow and we retain our call for a cut in July before pausing for at least one meeting thereafter.
Darcy Keith