Disinflation will be the theme in the Canadian economy for the rest of the year, despite the inflation uptick in May.
Inflation rose to 2.9 per cent on a year-over-year basis in May, with a 0.6 per cent monthly increase, Statistics Canada reported on Tuesday. Core inflation measures also rose slightly after months of decline, but they stayed below the 3 per cent preferred upper range. On a month-over-month basis, prices rose by 0.6 per cent.
Read more of RSM Canada’s insights on inflation, the economy and the middle market.
While the increase in inflation will give the Bank of Canada a pause about cutting rates, a July reduction is still in the cards if June’s consumer price index data shows further disinflation.
Even if the policy rate drops to 4.5 per cent in July, it will remain sufficiently restrictive given the growth and inflation outlook.
The journey back to the Bank of Canada’s 2 per cent inflation target will see some bumps such as this month’s inflation data, but Canada will get there.
Overall, one month of inflation data will not change the direction of Canada’s reaching 2.5 per cent inflation this year, and another rate cut will not reignite inflation.
But the economy needs more rate cuts to bring relief to shelter inflation, to stimulate consumer spending and to encourage business investments—all essential components for growth.
The acceleration in prices comes entirely from services inflation, which stands at 4.6 per cent, up from 4.2 per cent in April, because of elevated wage growth. Wage growth is likely to ease toward the end of the year as hiring slows and the labour market rebalances.
Hiring has dropped for the past year as unemployment, especially among youth and new entrants in the labour force, has increased. As the demand for labour becomes in sync with supply, wage growth will moderate.
Bank of Canada Governor Tiff Macklem was decidedly dovish in his speech on Monday by suggesting that the economy can add jobs without pushing up inflation. One sure way to stimulate hiring is to cut rates.
The acceleration was broad-based, especially in cellular services—which had a smaller decline in prices compared to April, travel tours (6.9 per cent) and air transportation (4.5 per cent).
Groceries inflation rose by 2.9 per cent, up from a 2.7 per cent increase in April, but remains the lowest in years.
The takeaway
Though a July rate cut would widen the policy rate differential with the United States, the effect would be temporary since disinflation is also expected in the U.S. later this year. The temporary hit to the Canadian dollar would be worth the economic stimulation that rate cuts would bring.
