Time to celebrate falling inflation? Not yet, Desjardins says

The June CPI data showed prices for more than half of the basket's components were rising more than five per cent on an annual basis. REUTERS/Blair Gable (Blair Gable / reuters)

Even though headline inflation finally fell back to within the Bank of Canada's target range in June, anyone who pulled out their party hat to celebrate might have jumped the gun, according to Desjardins.

"Can policymakers rest easy? We're not so sure," Royce Mendes, managing director and head of macro strategy, said in a report on Thursday.

"Despite the welcome drop in headline inflation, the June price data show that the share of components rising faster than 5% per year remains above 50%."

The simple fact that headline inflation is back within the target range means the risk of further rate hikes is significantly lower than market-implied pricingRoyce Mendes of Desjardins

It's an issue Bank of Canada governor Tiff Macklem has flagged as concerning.

Mendes says a breakdown of the data showed inflation declined because of significant drops in a small number of major categories, particularly gasoline prices, which sank 21.6 per cent year-over-year.

Statistics Canada reported on Tuesday that consumer price growth slowed to 2.8 per cent annualized in June, the lowest level since March 2021. Excluding the gasoline component though, headline inflation would have clocked in at four per cent, the agency says.

The data showed mortgage interest costs, rent prices and groceries surged by 30.1 per cent, 5.8 per cent and 9.1 per cent, respectively, well above the central bank's ideal target of two per cent.

Further rate hikes less likely

"That said, the simple fact that headline inflation is back within the target range means the risk of further rate hikes is significantly lower than market-implied pricing," Mendes wrote.

Because of this, he says two-year Government of Canada bonds could rally as traders scale back their bets on another rate hike this year.

While the central bank's benchmark rate might not move higher, Mendes says investors hoping for rate cuts could be disappointed.

"Elevated measures of underlying inflation increase the odds that the policy rate won't be coming down anytime soon as central bankers remain concerned about a second wave of excess inflation," he said.

"That leaves limited room for rate cuts to be priced in until some of these measures of underlying price growth settle down. As a result, bond bulls will have to wait a bit longer to celebrate."

Michelle Zadikian is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @m_zadikian.

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