Canadian inflation surged in April, rising by 0.7% despite expectations that it would cool to 0.4% from 0.5% last month.
This led the headline rate to rise to 4.4%, up one-tenth higher from March, and three tenths higher than consensus, marking the first re-acceleration in the headline measure since June 2022. While stronger inflation for all items will be a less-than-welcome sight for the Bank of Canada’s top officials, the fact that price pressures have also risen in the metrics that they’ve highlighted as their preferred measures of core makes today’s report considerably worse. These measures—the 3-month annualised averages of CPI-median and CPI-trim—rose from 3.6% to 4.0% and 3.3% to 3.7%, respectively. As the Bank’s recent communications have placed an explicit focus on the upside risks to inflation, expressed worries about core inflation becoming stuck above 3%, and left the door open to future hikes if warranted by the data, we believe that markets are underpricing the risk of an additional insurance hike on June 7th.
Currently, the market-implied odds of a June hike sit at 34%, repriced up from 17% just prior to the report.
Today’s CPI report, which was the final piece of high-impact data ahead of the next BoC decision, compounds the evidence we received earlier this month to suggest that the Canadian economy is heating back up. For instance, job growth was twice as strong as economists had anticipated, while the housing market appears to have bottomed, with housing starts, building permits, home prices and sales volumes all surging.
After stripping out the noise, the inflation picture is clearly getting worse
Inflation rates, 3-month annualised moving averages
Looking deeper into the report, we see that almost all major components rose faster than the pace consistent with 2% inflation.
Even the two weakest components, recreation, education, and reading (+0.2% MoM) and alcohol, tobacco, and cannabis (+0.2% MoM), merely tracked in line with that pace; none were weaker. The single greatest contributor to inflation was gasoline (+6.3%), a notoriously volatile series, but even after stripping out its effects, prices rose by 0.5% in April, which would annualise to 6.2% if maintained over 12 consecutive months. At the risk of understating the facts, this is not consistent with the Bank’s 2% inflation target. The rise in gasoline prices wasn’t even the only reason for the 1.5% increase in transportation costs, as the cost of operating a vehicle jumped by 2.9% in April. At the very least, lower income Canadians saw a bit of relief with public transit fares falling by -1.1%. Other basic necessities also saw their prices rise at a blistering pace in April. Food rose by 0.4% MoM, primarily driven by a 0.8% rise in restaurant prices—a key sign of continued demand for discretionary services despite the past year of aggressive monetary tightening. Shelter was worse with costs rising by 0.6%, pushed higher by rising mortgage interest costs (+1.9%), rent prices (+0.9%), and home prices (+0.6%).
It is getting much more expensive in Canada to eat, to get around, to put a roof over one’s head, and to top it all off, healthcare prices rose by 1.4% in April as well.
In a global context, the latest increase in headline and core inflation metrics will draw the attention of investors and traders as it is the first time this has happened within G10 economies for some time. Furthermore, it has occurred in Canada where interest rates are the joint-third highest among G10 economies, the central bank was one of the first to call and end to its hiking cycle, the transmission of monetary policy is deemed to be fairly quick given the domestic housing market’s high leverage ratios, and the headline inflation rate is the lowest outside of Switzerland and Japan. While this definitely plays into the hands of those analysts suggesting that inflation is likely to remain structurally above 2% given the shocks to the global economy and those asserting that further loosening in the labour market is required for inflation to fall from 4% back to target, we think it is too soon to make any clear connection. However, the signs for the BoC are definitely concerning. Given the breadth of inflation pressures, the uptick in their preferred measures of the momentum in core inflation, and evidence that the housing market is bottoming out and the labour market is still showing signs of strength, the Bank of Canada may be forced to deliver an insurance rate hike at their June meeting. This is being reflected in market pricing of the BoC’s June meeting, with the implied probability of another 25bps hike rising from 17bps to 35%. This is helping to lift front-end Canadian bond yields, which in turn has driven the loonie to rally by a third of a percentage point, a move that we believe could extend in the coming weeks.
Warning signs flash across most top-line indicators
Jay Zhao-Murray, FX Market Analyst