August Inflation Hotter Than Expected

Shelter prices were up 6.0% on a year-over-year basis in August after increasing 5.1% in July. The rent index led the faster growth in shelter prices, which rose 6.5% year over year nationally after a 5.5% gain in July. Among other factors, a higher interest rate environment may create barriers to homeownership and put upward pressure on the index. While rent prices accelerated in eight provinces, those with the fastest price growth were Newfoundland and Labrador (+8.4%), Alberta (+6.5%), Nova Scotia (+9.5%) and Manitoba (+6.1%).

The mortgage interest cost index also contributed to the acceleration in shelter prices, rising slightly faster in August (+30.9%) compared with July (+30.6%).

Although year-over-year price growth for groceries slowed in August, price levels remained elevated. On a year-over-year basis, prices for food purchased from stores rose 6.9% in August compared with an 8.5% increase in July.

It is now likely that when the Bank of Canada meets again on September 6, the Governing Council will announce a pause in rate hikes. They will promise to remain ever vigilant, but there is a good chance that the overnight policy rate has peaked at 5%--up 1900% since March 2022. 

We will unlikely see the first drop in the policy rate until June of next year. The Bank will proceed slowly, taking rates down by 25 bp increments. The low in the policy rate will probably be around 3%, well above the pre-pandemic level of 1.75%.

Roughly 50% of the prices in the CPI are growing more than 5%, which is still very concerning for the Bank of Canada. Market rates moved up meaningfully on the news. With the 5-year government bond yield well above 4%, fixed mortgage rates will increase this week. The odds of another 25 bps rate hike this fall have risen, but there is still another employment report and the September CPI release before the next announcement date on October 25th. 

Gasoline prices in September thus far have already risen to 10% above year-ago levels, so September inflation is likely also high. The additional problem for the Bank of Canada is that core inflation measures have also risen and will likely remain sticky on the high side. This has increased the odds of another rate hike this year. 

Mitigating the Bank's inflation concerns is the slowdown in economic activity. Employment growth has slowed as the jobless rate rose to 5.5% and job vacancies fell. Excess demand has also fallen. Financial strains in the household, financial and business sectors are emerging as delinquency rates on non-mortgage debt have soared. A pause in BoC rate hikes is warranted, but if the economy starts to pick up again or core inflation continues to hold steady or rise, additional rate hikes cannot be ruled out.