Lower inflation hints at later rate hike

Fears of a September interest rate increase were partially allayed this morning, when StatsCanada reported lower than expected inflation for the month of June.

The overall inflation rate for the 12 months ended June 30 was 3.1%, down from 3.7% for the year ending May 31.

More importantly, the core inflation rate declined from 1.8% in May, to 1.3% in June. Most of that decline was attributable to lower prices on passenger vehicles and traveller accommodation.

The Bank of Canada uses the core inflation rate in determining monetary policy, so the 50 basis point decline suggests Bank governor Mark Carney made the right call on Tuesday, when he announced no change in the overnight rate.

Read: Carney bound by macro forces

The decline in the overall inflation rate may also have been partially attributable to the effects of Ontario and British Columbia’s HST having worked through the system, according to RBC Economics.

“We estimate that this tax change added 0.4 percentage points to the headline rate during the past year and look for a similar-sized reduction”, wrote Dawn Desjardins, assistant chief economist, RBC Economics. “This points to the headline rate moving back within the Bank of Canada’s 1% to 3% target range for the next few months.”

She warned that HST-related refunds to businesses may cause a rebound in the core rate in the second half of the year.

“With both the headline and core inflation rates forecast to gravitate to the 2% target, the Bank will be keying off the momentum in the domestic economy as the catalyst to begin to remove policy stimulus,” she wrote.

Doug Porter, deputy chief economist for BMO Capital Markets, said the latest figures give the Bank of Canada breathing space before it must raise rates.

“Today’s much more benign reading for both headline and core inflation takes the near-term pressure off the Bank of Canada to do anything quickly on rates—assuming of course we don’t get yet another massive reversal in prices next month.”

Avery Shenfeld, chief economist at CIBC, said the report likely surprised the central bank, especially the core rate.

“All told, some key breathing room for the (bank) since even though the core rate will likely drift up as some low numbers drop out from the 12-month calculation in the coming quarter, odds now favour it remaining below 2%.”

The breakdown

While the pace of inflation slowed, higher prices for gasoline and food bought from stores kept the rate above 3%.

Food prices rose 4.8% from June of 2010 and overall energy prices were 15.7% higher than a year earlier.

The price of gasoline was 28.5% higher on a year-over-year basis, although it actually dropped slightly compared with May.

The inflation report came just days after the Bank of Canada said it would keep its key interest rate at 1%.

Consumers were still paying more for many commodities.

The cost of transportation rose 7.0% on an annual basis to June. In addition to higher gas prices, drivers paid 4.4% more for insurance. The cost of air travel was 7.6% higher.

Food prices rose broadly on a year-to-year basis. Meat prices increased 5.9%, while the cost of bread jumped 10.1% and fresh vegetables cost 8.4% more. The cost of restaurant meals, however, rose by only 3.3%.

Shelter costs rose 1.7% from June 2010, with higher prices for fuel oil, electricity. However, mortgage interest costs slipped 1.9% and natural gas was also cheaper.

Cable and satellite services cost 7.9% more than in June 2010.

The pace of inflation slowed in every province compared with May. Nova Scotia had the fastest increase in consumer prices at 4.4%, while Alberta had the slowest, at 2.1%.