Canada’s annual rate of inflation unexpectedly rose in May, putting a July interest rate cut by the Bank of Canada into question.
Statistics Canada announced Tuesday that the annual rate of inflation — as measured by the Consumer Price Index — rose to 2.9 per cent in May, up from 2.7 per cent in April.
It was the first increase after four straight months of falling inflation.
A consensus of economists surveyed by Bloomberg had expected May’s inflation would fall to 2.6 per cent.
BMO chief economist Douglas Porter said the Bank of Canada is now less likely to cut rates at its next meeting July 24.
“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 followup July rate cut,” said Porter. “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.”
Pedro Antunes, chief economist at the Conference Board of Canada, said the increase caught many observers off-guard.
“This was definitely a bit of a surprise,” said Antunes, who suggested that another increase could be coming when the June inflation numbers are released July 16.
“I do worry about next month, because right now we’re seeing oil prices climb back up,” said Antunes.
The Bank of Canada now has enough ammunition to do what it likely wanted to do anyway, Antunes argued. With the U.S. Federal Reserve not likely to start cutting interest rates south of the border until September, the Bank didn’t want to get too far ahead of its American counterparts, he said.
“This just reinforces that position for the Bank. They want to be very prudent on the way down anyway,” said Antunes. “We saw in the statements from their last meeting that there was still a lot of back-and-forth around whether this was a good time to lower rates or not.”
May’s increase was driven by a rise in prices for travel, but also grocery inflation, which rose for the first time since June of last year. Grocery prices were 1.5 per cent higher in May than a year ago, up from 1.4 per cent in April. Rent was also a big contributor, rising by 8.9 per cent over the last year.
The next interest rate announcement is scheduled for July 24. On July 16, Statistics Canada releases inflation numbers for June.
Traders also lowered their expectations of a July rate cut after seeing Tuesday’s inflation numbers. In trading on the overnight interest swaps market, the odds of a cut dropped from 60 per cent to 45 per cent after the inflation news.
Still, not everyone’s convinced the idea of a July interest rate cut is a non-starter. Arlene Kish, director of Canadian economics for S&P Global Market Intelligence, argued that a single month isn’t enough for the Bank of Canada to change course.
“The central bank will not be swayed by May’s acceleration in prices as there are no expectations of a smooth path down to the two per cent target,” wrote Kish, who’s still predicting a rate cut of 25 basis points — a quarter of a percentage point — in July.
In mid-June, the Bank of Canada dropped its key overnight lending rate to 4.75 per cent from five per cent, citing falling inflation over the previous four months.
Inflation peaked at 8.1 per cent in June 2022, as the Canadian economy opened back up from COVID-related restrictions.
The Bank raised rates 10 times between March 2022 and last summer in a bid to wrestle inflation down to its two per cent target.
The theory is that by making it more expensive to borrow money, consumers and businesses will spend less, driving down prices and slowing the economy.
