June’s inflation report in Canada confirms that the economy is on a disinflationary trajectory as headline inflation dropped to 2.7% because of slower growth in gasoline prices.
On a monthly basis, the consumer price index fell by 0.1% after a 0.6% increase in May. On a seasonally adjusted monthly basis, the CPI rose by 0.1% in June.
We believe that the Bank of Canada should cut the policy rate by 25 basis points next week, which would bring it to 4.5%.
Inflation is on track to reach 2.5% this year and return to 2% next year. Keeping the policy rate unnecessarily restrictive risks a policy error and raises the odds of a recession. Even with rate cuts, the policy rate will still be high enough for inflation to return to target.
In addition, disinflation in the United States points to a rate cut by the Federal Reserve in September, which would limit the divergence in the policy rates between the Bank of Canada and the Fed and limit the risk of the Canadian dollar losing more value against the American dollar.
The data
There was no surprise in the data as all categories saw broad-based disinflation. Core inflation measures showed little change, and both the core and headline numbers remain below the 3% upper range.
Shelter inflation, the most stubborn category, is showing signs of slowing thanks to the increased supply of new condos. The housing units that got started in the 2020-21 construction boom spurred by rock-bottom rates are now hitting the market.
Asking rents rose by 7.0% over the past year, the slowest rate in 13 months. In some cities, like Toronto and Vancouver, rents dropped on an annual basis as supply grew faster than demand.
Read more of RSM Canada’s insights on inflation, the economy and the middle market.
Gasoline prices rose by 0.4% in June after a 5.6% increase in May. On a monthly basis, gasoline prices fell by 3.1% as OPEC announced it would phase out voluntary production cuts.
Prices of durable goods dropped by 1.8% on a year-over-year basis, which further contributed to easing inflation. Consumers are spending less on discretionary purchases as they are squeezed by high interest rates and higher mortgage interest payments, as well as high rents. Lower demand for durable goods, combined with improved supply, pushed prices down.
Groceries rose by 2.1%, up from last month’s 1.6% gain, but this increase remains in line with the Bank of Canada’s inflation target.
The takeaway
At this point, most categories are on the disinflationary track. The challenge for consumers is that while inflation will continue to decrease, price levels are much higher than they were a few years ago, and that is something that can only get more palatable with higher income levels.
While shelter inflation might see some temporary relief because of increased supply, mortgage interest payments remain the largest challenge to disinflation. For this reason, more rate cuts are needed to bring inflation back to 2%.
