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The Globe and Mail: Inflation Up Lowers Odds of a July Rate Cut

The Globe and Mail: Inflation Up Lowers Odds of a July Rate Cut

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    The Globe and Mail: Inflation Up Lowers Odds of a July Rate Cut

    On June 25th, the Globe and Mail reported that Canada’s inflation rate unexpectedly rose in May, driven by higher service prices, making a July interest rate cut by the Bank of Canada (BoC) less likely. The Consumer Price Index (CPI) increased by 2.9% annually, surpassing expectations of 2.6%. In May, the BoC’s preferred ways to measure core inflation, which excludes more unpredictable changes in CPI, increased to 2.85% annually, up from 2.7% in April.

    • CPI increased to 2.9% in May, more than expectations.
    • May’s inflation reduced the chances of a rate cut on July 24th by 20%.
    • BoC will rely on more data from June CPI and US data for its July rate decision.

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    Despite a recent rate cut to 4.75%, doubts about further cuts have emerged due to inflation data. The services sector saw a significant price increase, with travel tours, air transportation, and rents experiencing notable rises. While some economists still believe a rate cut in July is possible, upcoming data releases will be crucial in determining the central bank’s next move. 

    Douglas Porter, the chief economist at BMO, expressed his concerns about the current situation, noting that it does not align with the BoC’s expectations. Porter also said that this could impact the rate cut in July. Porter emphasized the unpredictability of inflation, leading to uncertainty regarding the BoC’s future decisions.

    According to Royce Mendes from Desjardins Securities, price pressures have decreased in recent months, so last month’s CPI may simply be a correction. Mendes noted in a client memo that despite predicting another rate cut in July, upcoming data on employment and inflation will be crucial in deciding whether it will occur. The BoC expects inflation to decrease in the second half of 2024 and reach its 2% target next year. Updated economic projections will be provided at the July rate decision.

    From March 2020 to the present, inflation has varied between 1% and 3% for 9 months, while for 43 months, it has been either below 1% or above 3%. BoC has only fulfilled its monetary policy mandate around 17% of the time. Lowering interest rates before getting inflation under control could have significant repercussions.

    The potential impact of the 12-month base-year effect from June 2023’s CPI could lead to higher inflation figures in June 2024 despite June 2023 having the lowest inflation rate for the entire year. If inflation reaches 3% in June, the Bank of Canada might face a challenging situation. Failing to tackle rising inflation could damage the central bank’s credibility and reduce market expectations for rate cuts, potentially causing further issues in the financial system.

    The increase in May CPI growth was surprising, marking the first significant upward change. The 3-month growth rates for the median and trim measures surpassed the 2% inflation target, but the year-to-date averages remain steady at 2%. The BoC closely monitors data and will pay close attention to the June CPI numbers before making any decisions in July. However, with decreasing per-capita GDP and a rise in unemployment, there is a higher likelihood that price growth will continue to slow down overall.

    The BoC will get one more CPI reading on July 16th, greatly impacting market expectation and their decision for the July 24th announcement, making the next CPI release even more significant. After the CPI news, market expectations of a rate cut by the BoC on July 24th dropped from 63% to 43% (based on nesto’s proprietary data). The Government of Canada’s 5-year yield increased by 9bps the morning the CPI data was released. However, there was no immediate impact on lender’s mortgage rates

    The US GDP data will be released on June 27th, while the Canadian GDP and US PCE Inflation will be released on June 28th. The consumer spending report is the US Federal Reserve’s preferred indicator. The US economy is anticipated to experience a more significant slowdown in the upcoming months as the effects of extensive deficit spending and pandemic savings gradually diminish.

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