Inflation decelerated more than expected, but momentum remains elevated

Economic insight provided by Alberta Central Chief Economist Charles St-Arnaud.

Bottom line

Inflation decelerated to 2.8% in May, its lowest level since March 2021. The lower inflation rate is largely the result of lower gasoline prices, while shelter costs, especially mortgage interest payments and rent, and food prices remain significant sources of inflation. There are continued signs of modest moderation in underlying inflationary pressures, with most measures of core inflation easing in June below 4%.

However, inflationary pressures remain broad with almost half (49%) of the components of CPI rising at more than 5%, compared to 51% in April. Similarly, the share of components rising by more than 3% increased slightly to 67% (see Fig 1.) Little progress in the reduction in the percentage of components rising by more than 3% and 5% continues to worry the Bank of Canada as it is a sign that inflation remains broad-based.

The recent trend in CPI’s monthly changes suggests that the momentum in inflationary pressures is easing. Moreover, we can observe that many of the 3-month annualized changes in many CPI components are lower than the year-on-year changes or slightly above, suggesting continues moderation in inflation, except for shelter costs that are accelerating due to mortgage interest costs (see Fig. 2). The 3-month annualized changes in headline CPI is now at 2.6%, within the BoC’s target band. However, the same measure for the BoC’s core measures increases 3.8% on average, suggesting continued strong price pressures. CPI excluding food and energy is at 2.5%, in line the BoC’s target range, while it is 2.7% for the BoC’s old measure of core (CPI ex the 8 most volatile components and indirect taxes).

Inflation continues to moderate, but inflationary pressures remain broad and sticky. The BoC is likely to consider the recent dynamic in its measures of core inflation, as measured by the 3-month annualized changes that is still above 3%, which is slightly concerning.

However, higher interest rates are having a significant impact on inflation. We estimate that inflation excluding food, energy and mortgage interest payments is about 2.2% and its 3m/3m annualized change is around 1.4%. This means that excluding the impact of the rate hikes, underlying inflation is well in line with the BoC’s target.

June will likely mark the lowest point for inflation in 2023, as the base effect that brought inflation down since the beginning of the year will gradually fade away. As such, inflation is expected to rise above 3% in the coming months. While inflationary pressures remain high and the short-term dynamic suggests some stickiness in core inflation, we believe the BoC will be patient and will stay on the sideline for some time. The decision to raise rates again hinges on whether the domestic economy slows, reduces excess supply, and further moderation in inflationary pressures. In the coming months, a lack of progress on both fronts could trigger further hikes.

In Alberta, inflation dropped to 1.9%. The deceleration was mainly the result of a sharp decline in energy costs (-24.3% y-o-y), especially gasoline and natural gas prices. As such, energy costs are reducing inflation by 1.0 percentage points. Food prices decelerated and remain one of the main sources of inflation. Inflation excluding food and energy (a measure of core inflation) dropped to 2.9.

The Consumer Price Index (CPI) increased by 0.1% m-o-m non-seasonally-adjusted in June and the inflation rate moderated to 2.8%, its slowest pace since March 2021. It is also the first time since March 2021 that inflation in within the BoC’s target. Prices rose on the month in five of the eight major CPI components, led by transportation (+1.2% m-o-m), as gasoline prices rose 1.9% on the month, and shelter cost, due to a 1.8% m-o-m increase in mortgage interest cost. Food prices rose a meagre 0.1% m-o-m in June, its smallest monthly increase since March 2021. A decline in clothing and footwear (1.7% m-o-m) due to seasonal sales, household furnishing and equipment (-0.6% m-o-m) as a result of lower mobile phone costs, and in recreation, education and reading (-0.8% m-o-m), from a decline in travel services cost, were a drag on the CPI in June

Sevon of the eight major CPI components decelerated in June on a year-on-year basis. Food prices remain the main source of inflation increasing by 8.3% y-o-y, contributing 1.4 percentage points (pp) to inflation. Prices at grocery stores, especially for bakery products, were the main source of food inflation. Shelter costs accelerated to 4.8% and remain one of the main sources of inflation, contributing 1.4 percentage points (pp), with about 1.15pp attributable to higher mortgage interest costs and 0.4pp due to higher rent. Transportation costs declined 3.4% y-o-y, reducing inflation by 0.6pp to inflation, with gasoline prices being the main drag on inflation by declining 21.6% y-o-y. Household operation costs moderated to 0.3% y-o-y (contributing 0.0pp), with the deceleration attributable to a lower mobile phone services and childcare costs.

In June, goods prices inflation decelerated to 1.4% from 2.1%, its lowest since February 2021, while services inflation moderated to 4.2% from 4.6%. Energy prices dropped 14.6% y-o-y compared to the same month last year. Excluding food and energy, prices were flat on the month and rose by 3.5% compared to the same month last year, its lowest level since December 2021. The Bank of Canada’s old measure of core inflation, CPI excluding the 8 most volatile components and indirect taxes, moderated to 3.2%, its lowest sine June 2021.

Looking at the BoC’s core measures of inflation, all three indicators decelerated in June. CPI-Median eased to 3.9% from 4.0%, CPI-Trim to 3.7% from 3.8%, and CPI-Common to 5.1% from 5.2%. As a result, the average of the three measures moderated to 4.23% from 4.33%.

In Alberta, inflation moderated to 1.9% in June from 3.4%, its lowest level since February 2021. The main source of deceleration in inflation was from transportations cost, declining 4.7% y-o-y and reducing inflation by 0.8pp mainly as a result of lower gasoline prices (-24.3% y-o-y). Food prices moderated to 7.9% y-o-y and are the main source of inflation in the province, contributing 1.3pp to inflation. Shelter costs decelerated in June, increasing by 4.6% y-o-y, compared to 5.1% y-o-y the prior month, contributing 1.2pp to inflation. This easing in shelter costs was due to a decline in natural gas prices (-31.3% y-o-y) in June, reducing inflation by 0.4pp to inflation. Food prices accelerated to 8.3% y-o-y and the main source of inflation in the province, contributing 1.4pp to inflation. Recreation, education and reading costs decline 1.4% y-o-y, mainly as a result of lower travel servies costs.

Goods price inflation decelerated to 0.7% from 2.5%, while services prices eased to 3.1% from 3.7%. Inflation excluding food and energy dropped to 2.9%, its lowest since January 2022, while energy costs declined 17.1% y-o-y due to lower gasoline amd natural gas prices compared to last year.