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Canada’s inflation rate fell in June to within the Bank of Canada’s target range of 1% to 3%. Core prices, however, including groceries and mortgage costs, still remain high. Robert Both, Macro Strategist with TD Securities, discusses the implications for interest rates.
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So we just got the latest Canadian inflation numbers this morning. What's your take?
So it's not too common where you see headline inflation and core inflation surprise in the opposite direction. Core inflation measures were a little bit stronger than we had expected today, but you did see headline come in much softer at 2.8%. So while it's certainly encouraging to see inflation back inside that target range, like you said, for the first time in over two years, we're really not going to draw too much comfort from that until we do see a little more progress in those core measures coming lower.
Sure. So one of the questions we've been getting quite frequently over the last few months has been the growing importance of mortgage interest costs as a driver of headline inflation. So mortgage interest costs are running at about 30% year over year in June. That's not too different than they were in May. But that's contributing about 0.8 percentage points to inflation, which, when it's only running at 2.8% year over year, is a very large share of the overall year over year increase.
However, we think that just simply excluding mortgage interest costs, because the Bank of Canada does impact those through rate hikes, would be the wrong approach here. We think it's a little dangerous to simply just pick and choose which components you'd like to drop. The Bank of Canada, obviously, has its own tools for looking past more volatile changes across the individual basket.
Those tools, like core inflation measures, do a good job of stripping out those larger movements that are maybe not moving in the same direction as the rest of the basket. So the Bank of Canada is keenly focused on those core inflation measures because of some of the more volatile changes across the basket. But as we said, core inflation measures are running quite a bit stronger, so there's obviously something else besides mortgage interest that is driving prices here.
Well, I think the Bank of Canada is in a wait and see mode after the July policy decision. You know, generally, when headline inflation and core inflation are surprising in opposite directions, you know, that's an environment where the bank is probably going to want to see a little more evidence of how those are going to develop over the next month or two before it commits to any path on future policy decisions. So the sharp drop in headline alongside the persistence in core does speak to a couple larger one off factors that weighed on headline CPI in June.
One of those was household communications. So these have been a bit of a drag on the index for several years, but cell phone plans fell quite sharply over both May and June. Statistics Canada was attributing some of that to new cell phone plans and promotional events from major telecoms. That's not something that's going to continue declining at 5% month over month going forward.
Similarly, we saw a very large drag in travel services, as some of those post-pandemic travel boom subside and prices start to normalize. That's something that might continue to play out further over the coming months. But the presence of those large one off moves does speak to the importance of core inflation. And that continued persistence in core inflation is something that's probably going to concern the Bank of Canada or add to their already significant concerns.
But September is still a long ways off. Headline inflation is back inside the target range. So I think we are going to have to wait and see how this plays out over the next month or two.
Now, we know, of course, September is a long way away, but what will you be watching closely? What indicators will you be looking at as the Bank of Canada considers its next move?
So the bank has laid out what they are watching as they approach the September policy decision. Those factors are the evolution of excess demand. They are the evolution of corporate pricing behavior, inflation expectations, and wage growth.
Those have painted a somewhat mixed picture over the last few months. We have seen wage growth come off. We've seen some progress on inflation expectations. But both wages and inflation expectations remain too high for the bank's comfort.
They remain well above pre-COVID norms. And we're going to need to see more evidence of those continuing to trend lower into the fall. Corporate pricing behavior is a little more opaque to those that don't study it as closely.
That's something I think we're going to have to maybe take the bank's word on, or at least something we'll see when inflation subsides. But we're mostly focused on the wage growth metrics and the evolution of those core inflation numbers.
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So it's not too common where you see headline inflation and core inflation surprise in the opposite direction. Core inflation measures were a little bit stronger than we had expected today, but you did see headline come in much softer at 2.8%. So while it's certainly encouraging to see inflation back inside that target range, like you said, for the first time in over two years, we're really not going to draw too much comfort from that until we do see a little more progress in those core measures coming lower.
- So talk to us about mortgage interest costs, which is becoming an outsized influence on headline inflation.
Sure. So one of the questions we've been getting quite frequently over the last few months has been the growing importance of mortgage interest costs as a driver of headline inflation. So mortgage interest costs are running at about 30% year over year in June. That's not too different than they were in May. But that's contributing about 0.8 percentage points to inflation, which, when it's only running at 2.8% year over year, is a very large share of the overall year over year increase.
However, we think that just simply excluding mortgage interest costs, because the Bank of Canada does impact those through rate hikes, would be the wrong approach here. We think it's a little dangerous to simply just pick and choose which components you'd like to drop. The Bank of Canada, obviously, has its own tools for looking past more volatile changes across the individual basket.
Those tools, like core inflation measures, do a good job of stripping out those larger movements that are maybe not moving in the same direction as the rest of the basket. So the Bank of Canada is keenly focused on those core inflation measures because of some of the more volatile changes across the basket. But as we said, core inflation measures are running quite a bit stronger, so there's obviously something else besides mortgage interest that is driving prices here.
- So with this number today, what impact will this inflation data have on Bank of Canada monetary policy going forward? And do you think the Bank of Canada is done rate hikes this year?
Well, I think the Bank of Canada is in a wait and see mode after the July policy decision. You know, generally, when headline inflation and core inflation are surprising in opposite directions, you know, that's an environment where the bank is probably going to want to see a little more evidence of how those are going to develop over the next month or two before it commits to any path on future policy decisions. So the sharp drop in headline alongside the persistence in core does speak to a couple larger one off factors that weighed on headline CPI in June.
One of those was household communications. So these have been a bit of a drag on the index for several years, but cell phone plans fell quite sharply over both May and June. Statistics Canada was attributing some of that to new cell phone plans and promotional events from major telecoms. That's not something that's going to continue declining at 5% month over month going forward.
Similarly, we saw a very large drag in travel services, as some of those post-pandemic travel boom subside and prices start to normalize. That's something that might continue to play out further over the coming months. But the presence of those large one off moves does speak to the importance of core inflation. And that continued persistence in core inflation is something that's probably going to concern the Bank of Canada or add to their already significant concerns.
But September is still a long ways off. Headline inflation is back inside the target range. So I think we are going to have to wait and see how this plays out over the next month or two.
Now, we know, of course, September is a long way away, but what will you be watching closely? What indicators will you be looking at as the Bank of Canada considers its next move?
So the bank has laid out what they are watching as they approach the September policy decision. Those factors are the evolution of excess demand. They are the evolution of corporate pricing behavior, inflation expectations, and wage growth.
Those have painted a somewhat mixed picture over the last few months. We have seen wage growth come off. We've seen some progress on inflation expectations. But both wages and inflation expectations remain too high for the bank's comfort.
They remain well above pre-COVID norms. And we're going to need to see more evidence of those continuing to trend lower into the fall. Corporate pricing behavior is a little more opaque to those that don't study it as closely.
That's something I think we're going to have to maybe take the bank's word on, or at least something we'll see when inflation subsides. But we're mostly focused on the wage growth metrics and the evolution of those core inflation numbers.
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