Inflation rate dropped to 3.4% in May. What that means for the Bank of Canada

Last month saw a significant decrease in the yearly inflation rate, although some financial analysts believe that this deceleration may not be sufficient to dissuade the Bank of Canada from implementing another interest rate raise in July.

On Tuesday, Statistics Canada reported that the yearly rate of inflation for May dropped significantly to 3.4 percent.

The majority of economists were anticipating a significant decline in the headline inflation rate for last month. This comes after it had increased to 4.4% in April in an unexpected turn from the 4.3% in the previous month. Furthermore, this marks the first instance in which the inflation rate has increased in the past ten months.

In the May inflation report, RBC Economics had predicted that the decrease would be less significant, with a decline of only 3.6 percent.

According to Nathan Janzen, who works as an assistant chief economist at RBC and was interviewed by Global News, the most significant element influencing the situation is the contrast between the trends of energy prices this year compared to the previous year. According to Statistics Canada, the prices of energy had decreased by 12.4% in May when compared to the previous year.

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Gasoline and oil prices rose extensively in the early months of 2022, which was due to the invasion of Ukraine by Russia. Janzen highlighted that since the surge in prices occurred during a seasonal period, it will not affect the annual inflation data, thus reducing the year-to-year price growth.

At the same time, according to Statistics Canada, the increase in grocery prices continued to be high, with a growth of 9.0 percent compared to the previous year, which is almost the same as the increase seen in April.

The agency reported that there has been an increase of 20.3% in the prices of edible oils and fats. Similarly, bakery products have experienced a rise of 15% in their costs while cereals are now 13.6% more expensive than before.

A recent report from Statistics Canada revealed that the rate of inflation on food bought from restaurants increased during May. This was caused by the persistent shortage of workers affecting employers in the service industry.

News about the continuous increase of food prices in May was published on the same day as the Competition Bureau's investigation into Canada's grocery industry. The probe revealed that the lack of competition is causing prices to rise.

According to StatCan, the primary reason for the uptick in monthly CPI figures is the escalation in mortgage costs. This escalation can be attributed to the increased interest rates from the Bank of Canada. The mortgage cost index recorded an annual uptick of 29.9%, which is the largest increase on record for three consecutive months.

Cellular services have experienced a significant price reduction of 8.8% compared to the previous year, marking the largest drop since April 2022. Furniture prices have also undergone a decrease of 2.9%, while passenger vehicle prices registered a modest increase of 3.2%, which is the smallest growth since February 2021.

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At 5:05, the Parliamentary Committee discovered that grocers are not fully responsible for the high rates of food prices.

Bank Of Canada's Next Move?

According to Janzen, the release of the CPI on Tuesday is of utter importance to the Bank of Canada as it determines whether it is necessary to further jolt the economy by implementing another rate hike in July.

According to him, the Bank of Canada will not give much importance to the decrease in the yearly numbers due to their close relationship with the elevated prices of last year. Instead, he suggests that the policymakers will focus more on the monthly trends and the preferred inflation rates of the central bank, commonly known as the "core measures". This will help in determining if the prices are under control or if adequate measures need to be taken to reduce them.

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The Bank of Canada has recorded a slight drop in their ideal measures for CPI-median and CPI-trim between April and May, but the numbers are still higher than usual at 3.9 per cent and 3.8 per cent.

According to Andrew Grantham, a prominent economist at CIBC, these measurements are still high, but fell below what many economists predicted. This could potentially persuade the central bank to hold off on raising interest rates until later than July.

Janzen observes that inflation often acts as a "retroactive signal," revealing the outcomes of economic events that have already taken place.

Benjamin Reitzes, who works as the managing director of Canadian rates and macro strategist at BMO, stated in a note on Tuesday that all measures of inflation are much higher than the targeted rate of two per cent. Therefore, the policymakers at the Bank of Canada won't feel completely reassured after this report because the central measure of inflation is still high and hasn't started to show any clear signs of slowing down yet.

There are other economic updates scheduled before the July 12 interest rate decision, including the employment report for June and the Bank of Canada's business outlook survey. These updates will provide insight into whether or not the Bank of Canada has done enough to bring inflation down to two percent.

According to him, those are all cues that they will rely on to predict the direction of inflation in the future rather than simply measuring its current state.

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According to Janzen, there needs to be clear indications of a slow-down in these economic updates to prompt the Bank of Canada to halt its actions. He believes that if policymakers did not deem a 425 basis point policy rate increase sufficient, an additional increase of 25 basis points wouldn't convince the central bank that inflation will reach its desired level of two percent.

The Federal Reserve of the United States has decided to maintain the current key rate and has provided indications of future increases in interest rates.

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