Canadian CPI rises to 2.9% in May

Economists and rate watchers were in for a surprise this morning, as the latest inflation report came in higher than forecasted, potentially derailing expectations for a rate cut in July.

Statistics Canada reports that the Consumer Price Index (CPI) rose 2.9% on an annual basis in May, following its 2.7% reading in April. On a monthly, basis, the CPI is up 0.6%. According to StatCan, the headline inflation measure was driven higher mainly due to rising service prices – led by cellular services, travel tours and air transportation – which increased 4.6%, following April’s uptick of 4.2%. 

Food prices also rose 1.5%, up slightly from 1.4% last month, but marking their first increase since June 2023. StatCan points out that, overall, grocery prices now sit 22.5% higher than in May 2020.

Rising rents drive inflation higher

Shelter inflation, a top contributor to the CPI basket, stayed flat at 6.4%. Mortgage interest costs dipped lower, to 23.3% from 24.5% last month due to slightly easing mortgage rates. However, this was outweighed by rising rents, up 8.9% this month from April. Rents are heating particularly quickly in Ontario, says StatCan, up sharply to 8.4% in May from 6.1% the previous month.

“This contributed to faster growth in the national rent index, which rose 8.9% in May, outpacing growth in Ontario for the ninth consecutive month,” reads the inflation report. “A higher interest rate environment and population increases both continue to put upward pressure on the rent index nationally.”

May CPI surprises on the upside

The May reading bucked expectations that the CPI would lower again in May. Prior to StatCan’s release, RBC economists Nathan Janzen and Abbey Xu wrote that the lenders' call was for a reading of 2.6%, based on the expectations for softer gas prices. 

Now, all eyes are on the Bank of Canada and how it will take the news; had the May CPI come in lower than April’s, it would have strengthened the argument for a quarter-point rate cut in July.

That’s now less likely, especially as the “Core” inflation metrics – which are closely monitored by the central bank – also increased. The CPI median rose 2.8% compared to 2.6 in April, and the Trim increased 2.9%, up from 2.8 the month prior. Overall, though, inflation does remain within the BoC’s 1 - 3% target range, the fifth consecutive month where it has done so.

“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 follow-up July rate cut,” writes Doug Porter, Chief Economist and Managing Director of Economics at BMO following the CPI release. 

“However, it doesn't rule out such a move, as we will see one more CPI (next one is July 16, eight days before the July 24 rate decision). 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.”

Why is the Bank of Canada watching inflation?

Part of the BoC’s purpose is to keep inflation – and by extension, Canada’s currency – stable, and close to a target of 2%. To do so, the central bank influences inflation growth by increasing or decreasing the benchmark borrowing rate in Canada. When inflation is running too hot, the BoC will hike its rate, which in turn cools consumer spending and borrower demand. On the flip side, a too slack economy prompts the Bank to lower interest rates, which makes for a cheaper cost of living. This benchmark – officially referred to as the Overnight Lending Rate – sets the floor for Canada’s Prime rate, which in turn is used by lenders when pricing variable mortgage rates, and other floating-rate savings and investing products such as Guaranteed Income Certificates (GICs) and high-interest savings accounts.

The BoC has been fighting to pull inflation down to its 2% target since mid 2022, when the end of pandemic lockdowns and resulting supply-chain snarls caused the CPI to soar, eventually hitting a 40-year high in June of that year. In response, the BoC carried out a historically steep 10 rate hikes between March 2022 and July 2023, which brought its benchmark rate from 0.25% to 5%. It then left its rate at this multi-decade high for 11 months, breaking its rate hold on June 5 with a quarter-point rate cut – its first decrease since March 2020. Economists largely believe the central bank will cut its rate around four times by mid 2025, bringing the cost of borrowing down by a full percentage point – as long as inflation falls in line, that is.

However, as Porter points out, there’s still one more CPI reading to come before the BoC’s next announcement in July – and that should provide more insight on whether May’s numbers are but a blip.

The next Bank of Canada announcement is on July 24, 2024.

Also read:

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• What does another US Federal Reserve rate hold mean for Canadians?
• Toronto home sales fall 22% in May as buyers await rate cuts
• How does inflation impact insurance in Canada?
• Bank of Canada cuts target interest rate to 4.75% in June 2024 announcement