Canada: Slowing Inflation Reinforces Our Call for Three More Cuts This Year

Good news on the inflation front just keeps on coming. According to Statistics Canada, the “deceleration in headline inflation was broad-based, stemming from lower prices for travel tours, passenger vehicles and electricity.” Some of this reflects lingering pandemic effects that are still coming out in the wash, such as slower growth in the cost of travel-related services relative to the spike in prices when most travel restrictions were lifted a year earlier. There are parallels with the accumulation of auto inventories over the past year that has created a better balance between supply and demand for passenger vehicles, allowing prices to fall from the same time a year ago. This was particularly true for used vehicles. While still the largest contributing factor to total CPI inflation, even shelter inflation is starting to ease (graph 1), with year-over-year gains in mortgage interest cost, rent and shelter-related energy coming in slower than in June. Food prices also slowed over the prior month. And despite gasoline prices up almost 2% in July from the same time last year, energy overall was broadly unchanged from June.

Looking to underlying inflation, the Bank of Canada’s preferred measures of core year-over-year price growth—CPI median and trimmed mean—were down a couple of ticks from June (averaging 2.5% y/y), managing to stay under 3% for the fourth consecutive month. On a 3-month annualized basis, these measures stopped their recent acceleration, falling back to 2.7% after reaching a five-month high of 2.9% in June (graph 2). Meanwhile, the more universally referenced total CPI inflation excluding food and energy, inflation on a 3-month annualized basis held steady at just shy of 3.0% in July. That’s the third month in row this indicator has bumped up against the upper bound of the Bank of Canada’s operating band. However, on a year-over-year basis, it too slowed relative to June. And while the Bank’s former preferred measure of core inflation—CPIX (CPI excluding the 8 most volatile components & indirect taxes)—inched higher to 2.4% on a 3-month annualized basis, it managed to stay close to 2% again in July.

The breadth of price increases across components also showed more progress in July. The share of components growing above 3% on an annual basis fell to 30% from 34% in the prior month, well below the peak of 78% in 2022. Conversely, the share of components with annual rates of growth of less than 1% increased to 49% from 46% in June. Notably, there was significant progress in services, where the share of components growing above 3% fell from 47% to 41% in July. All of this bodes well for price stability and will undoubtedly give Canadian central bankers more confidence that inflation isn’t reaccelerating.

With inflation slowing again in July and gradually inching its way toward the Bank of Canada’s 2% target, it would appear that the Bank’s goal of returning to low and stable inflation is in sight. Indeed, the softening Canadian labour market has become a concern for Bank officials, although still respectable real GDP growth suggests a soft-landing is possible if the Bank of Canada gets the speed and magnitude of easing right. As such, we think the BoC will continue to gradually ease up on its restrictive monetary policy stance, reducing the overnight interest rate by 25 basis points in September, and again at the rate decisions in October and December of this year.