Inflation likely to fall in July – BoC gives reason for reduction

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The Bank of Canada is expected to cut its key interest rate at its next meeting in September. That cut will become even more likely if economists' predictions that inflation cooled further last month prove true.

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On Tuesday, Statistics Canada will release its consumer price index (CPI) data for July.

Inflation slowed to 2.7 percent year-on-year in June, reflecting a decline in gasoline prices. Despite rising to 2.9 percent in May, inflation has followed a cooling trend and remained within the target range of one to three percent since the beginning of the year.

The Bank of Canada expects core inflation – the measure it prefers to use in its monetary policy decisions – to fall to 2.5 percent in the second half of the year.

With the exception of the Royal Bank of Canada, economists are forecasting that Tuesday's inflation figures will decline in July, but there is no consensus on the exact number.

The Toronto-Dominion Bank estimates annual inflation at 2.4 percent in July. The Fédération des caisses Desjardins du Québec and the Canadian Imperial Bank of Commerce expect inflation to be 2.5 percent, and the Bank of Montreal predicts that it only fell to 2.6 percent last month.

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“The share of CPI components rising above three percent is approaching normal levels, which is encouraging and should help the Bank of Canada's preferred measures of underlying inflation make further progress,” said Jimmy Jean, chief economist at Desjardins.

Andrew Grantham, a senior economist at CIBC, said there will be monthly price increases, but these will be offset by the absence of higher gasoline prices compared to last year.

“We expect prices to rise by 0.4 percent month-on-month, which corresponds to a seasonally adjusted increase of 0.3 percent (the strongest since March),” he said in a note to clients. “Despite this significant monthly increase, however, the annual pace of inflation is still likely to slow as the larger increase in gasoline prices a year ago is no longer taken into account.”

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Jean said the final point in the inflation story is stubbornly high housing costs. Housing cost inflation eased slightly to 6.2 percent in June, from 6.4 percent in May. Mortgage rates remained the largest contributor to annual inflation in June at 22.3 percent, and rent inflation was 8.8 percent in the same month.

RBC forecasts stable inflation at 2.7 percent.

“The decline in inflation pressures in Canada has slowed in recent months,” said Nathan Janzen, deputy chief economist at RBC, in a note to clients.

He said even a stable inflation rate on Tuesday should not prevent another rate cut in September.

The central bank's next interest rate announcement is scheduled for next month. Economists are forecasting a further rate cut of 25 basis points.

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“Given what we know about inflation and the fact that it's doing quite well, it's become less of a concern for the Bank of Canada,” said James Orland, director of economics at TD. “The concern was that they should be slow to cut rates because they were afraid that inflation would pick up again, but everything we've seen with inflation is the opposite of that.”

Orland said interest rates remain too high and need to be lowered to promote sustainable economic growth and avoid significant job losses. The unemployment rate rose to 6.4 percent in June.

“Although the Bank of Canada would prefer a further slowdown, especially with reasonably benign base effects, stable core inflation will not prevent a further cut at the policy announcement in early September,” Benjamin Reitzes, economist at BMO, said in a note. “Fortunately, there is an even more benign base effect next month, suggesting we will at least get a benign reading ahead of the Bank of Canada's October meeting.”

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Last month, Bank of Canada Governor Tiff Macklem said there was still excess supply in the economy and signalled a more dovish stance, expressing concern that inflation could fall too far.

“We need growth to pick up so that inflation does not fall too much, even as we work to reduce inflation to the two percent target,” he said at the bank's last key interest rate announcement.

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