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Inflation slows to 3.4% in May, stoking rate-hold hopes

The latest inflation numbers are in for the month of May, and they signal a small victory for the Bank of Canada in its fight to reign in CPI and cool the economy.

The headline rate of inflation growth has slowed to 3.4% year over year, reports Statistics Canada – a welcome reversal from April’s hotter-than-expected reading of 4.4%, and its lowest since 2021. This is indeed good news for the central bank – and for borrowers – as it indicates recent rate hiking measures are effectively slowing consumer spending and paving the way for the Bank to return to a rate hold stance, rather than further increasing the cost of borrowing.

The Bank most recently hiked its trend-setting Overnight Lending Rate – which in turn sets the Prime rate and variable-rate mortgage costs at consumer lenders – by 0.25% on June 7. That brought the overall benchmark cost of borrowing to 4.75% – up 4.5% from its pandemic low of 0.25%. The hikes have been in efforts to pare down inflation growth, which soared to a 40-year high of 8.1% last June, following the end of pandemic lockdowns and resulting supply-chain snarls. The Bank needs to bring CPI back down to a target of 2% before it can take its foot entirely off the rate-hiking pedal.

According to StatCan, this most recent slowdown is due to softer gas prices, which fell 18.3% from last May. On a monthly basis, the measure rose 0.4%, lower than the 0.7% uptick recorded between March and April.

However, grocery prices remain stubbornly high – up 9% – squeezing consumers’ food budgets and purchasing power. “This increase was still more than double the rate of headline inflation and nearly unchanged from the 9.1% increase in April,” writes StatCan, which adds the highest year-over-year increases among grocery items include edible fats and oils (+20.3%), bakery products (+15.0%) and cereal products (+13.6%).

Rising mortgage interest costs fuelling inflation

Another main contributor to inflation is, paradoxically, rising mortgage costs; the interest cost index tracked by StatCan rose 29.9% year over year, following a 28.5% uptick in April. “This was the largest increase on record, as Canadians continued to renew and initiate mortgages at higher interest rates,” states the report.

This reflects how mortgage costs have soared as a result of the Bank of Canada’s hiking cycle, as well as bond market volatility; the best five-year variable mortgage rate today sits at 5.8%, up from 2.5% last year. Five-year fixed mortgage rates now sit as low as 4.94%, reflecting steep fluctuations in the bond market. Yields have been persistently elevated in recent weeks, following the steep April inflation print and consequent BoC hike 0.25% hike on June 7, with five-year government yields surging over 60 basis points over the last three months. Yields slid slightly this morning on the promising CPI news, easing about five bps to the 3.6% range.

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Of course, today’s reading poses the question for analysts and borrowers alike: will it be enough to prevent another rate hike in the BoC’s next announcement on July 12?

What is certainly promising is that in addition to the lower headline number, two additional metrics tracked by the Bank – the trim and median core rates – have also declined by 3.85%. This actually comes in lower than what had been forecasted by economists, and indicates the Bank could have room to hold rates moving forward. Initially the Bank expected to be able to reduce inflation to 3% by this summer.

However, while promising, not all economists are convinced the lower May reading will be enough to dissuade the Bank's Governing Council from one last hike come July. 

“Although slowing, underlying inflation trends in Canada are still running well-above the BoC’s 2% target,” writes RBC Economist Claire Fan in an analysis note.

“Higher interest rates are cutting into household purchasing power, but spending to-date has been firm. Labour market conditions are also more resilient than expected in 2023 to-date. GDP data and the BoC’s own Q2 Business Outlook Survey later this week will be watched closely for signs that the economy is losing momentum. But absent a large downside surprise from those data releases, we continue to expect the bank to hike the overnight rate by another 25 bp in July, before stepping back the sideline for the rest of this year.”

There are still two more significant data drops to be released over the coming weeks – Gross Domestic Product and employment numbers – that could prove to influence the central bank’s hand, due out on June 30th and July 7th, respectively. 

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