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Canada Inflation Quickens to 2.9%, Reducing Odds of July Cut

(Bloomberg) -- Inflation unexpectedly surged in Canada, a setback for policymakers as they weigh further interest rate cuts next month.

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The consumer price index rose 2.9% in May from a year ago, up from 2.7% a month earlier, primarily due to higher prices for services, Statistics Canada reported Tuesday in Ottawa. That was faster than the median estimate of 2.6% in a Bloomberg survey of economists.

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On a monthly basis, the index climbed 0.6%, versus expectations for a 0.3% gain and up from 0.5% in April. On a seasonally adjusted basis, inflation rose 0.3%.

The Bank of Canada’s two core inflation measures also accelerated, averaging a 2.85% yearly pace — faster than economists expected.

Tuesday’s data broke a four-month string of easing price pressures. The reacceleration of both headline and core inflation will likely caution the central bank against a second consecutive interest rate cut next month, as officials seek to understand whether the resurgence in price pressures is temporary.

“The inflation path remains uneven, which means the rate cut path likely won’t be smooth either,” Benjamin Reitzes, rates and macro strategist at Bank of Montreal, said by email. “While we won’t rule out a July cut, the odds just fell notably.”

Traders in overnight swaps pared bets that the Bank of Canada would ease again in July, putting the odds of a cut at that meeting at just over a third, from over 60% before the release of the CPI data. The Canadian dollar jumped on the release, but pared some gains to trade at C$1.367 per US dollar as of 10:44 a.m. Ottawa time. The yield on 2-year Canada bonds rose about 7 basis points on the day to just below 3.98%.

Governor Tiff Macklem and his officials lowered the benchmark overnight rate by 25 basis points to 4.75% earlier this month, the first Group of Seven central bank to kick off an easing cycle. After seeing several months of cooling price pressures, they said they were more confident inflation was headed to the 2% target and that monetary policy no longer needed to be as restrictive.

In a summary of the deliberations from their June meeting, policymakers said they considered holding rates steady in order see more inflation data and “gain further assurance” that it was time to start loosening monetary policy.

Importantly, officials said they were concerned that their progress on inflation could reverse as it did in the US, and Tuesday’s data raises questions about whether the central bank should have waited for more evidence before cutting borrowing costs.

“Today’s report won’t instill any added confidence for the Bank of Canada,” James Orlando, an economist at Toronto-Dominion Bank, said in a report to investors. “One bad inflation print doesn’t make a trend. But it does speak to the unevenness of the path back to 2%.”

Tuesday’s inflation release is the first of two such reports before the next Bank of Canada rate decision on July 24. Orlando and the majority of economists in a Bloomberg survey expect policymakers to hold borrowing costs steady at that meeting before easing again in September.

“The lack of progress in May reduces the likelihood that the Bank of Canada will cut in July. But with another CPI release before the July decision, the door is not completely closed,” Charles St-Arnaud, chief economist at Alberta Central, said in an email.

Macklem reiterated on Monday that it’s reasonable to expect further reductions in the policy interest rate if price pressures continue to ease. But officials don’t want to lower rates too quickly and jeopardize progress on inflation.

A three-month moving average of the inflation rate rose to an annualized pace of 2.52%, from 1.64% in April, according to Bloomberg calculations.

Shelter, Food Inflation

In May, mortgage interest costs and rent remained the biggest contributors to the annual change in the rate of inflation. Mortgage interest costs jumped 23% and rent rose 8.9% on a yearly basis. Excluding shelter costs, the consumer price index rose 1.5% from a year ago, versus 1.2% in April.

Excluding food and energy, the index rose 2.9% from a year ago, up from 2.7%. Services inflation was up 4.6%, compared with 4.2% in April.

Food prices rose 2.4%, versus 2.3% in April. Groceries increased 1.5% from a year ago, the first acceleration since June 2023, and rose 1.1% from the previous month — the biggest monthly gain since early last year.

Regionally, prices increased at a faster pace from a year ago compared with April in six of 10 Canadian provinces, including Ontario and Quebec.

The release incorporates new basket weights from Statistics Canada, but they didn’t impact the headline yearly CPI change, the agency’s analysts said.

What Bloomberg Economics Says

Reaccelerating inflation argues for the BoC cutting rates only slowly. One poor inflation report isn’t a trend, but we think the BoC will remain on hold at the July 24 meeting. With upside risks to inflation coming from home prices — which could rise as interest rates fall — and with only limited room to diverge from the Fed, we think the BoC will cut its overnight-rate target at just a quarterly cadence.

— Stuart Paul, economist

--With assistance from Jay Zhao-Murray.

(Updates with market reaction, analyst comments and chart from the seventh paragraph.)

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