Inflation Rate Declines, Strengthening Case for Bank of Canada Rate Cut

Canada’s inflation rate is steadily returning to the Bank of Canada’s 2 percent target, strengthening the case for the central bank to cut interest rates again next month.

In July, the Consumer Price Index (CPI) rose at an annual rate of 2.5 percent, down from 2.7 percent in June, according to Statistics Canada. This marks the lowest annual inflation rate since March 2021 and aligns with analyst expectations.

Inflationary pressures are easing across various sectors, with declines in prices for passenger vehicles, travel tours, and electricity compared to a year ago. Even the housing sector, a consistent source of financial strain, is showing signs of slight moderation.

Before the CPI release, most economists and investors anticipated a quarter-point interest rate cut by the Bank of Canada in each of its three remaining announcements this year, beginning with the September 4 decision. The report has only reinforced this expectation.

“An inflation report like this seals the deal for another quarter-point rate cut at the Bank of Canada’s September meeting,” wrote Tiago Figueiredo, macro strategist at Desjardins Securities, in a client note. He added that the report likely supports additional rate cuts in subsequent meetings.

The U.S. Federal Reserve is also expected to join in with its first rate cut of this cycle next month, after maintaining the federal funds rate at a range of 5.25 to 5.5 percent for over a year.

At its July meeting, the Bank of Canada’s governing council emphasized growing concerns about the downside risks to the economy and the possibility that inflation could drop below the 2 percent target. This represented a significant shift in the central bank’s approach to monetary policy.

Higher interest rates are weighing on the economy, particularly in the labor market, where the unemployment rate has risen to 6.4 percent, nearly two percentage points higher than the historic low recorded two summers ago.

“We need growth to start picking up,” Governor Tiff Macklem stated at a news conference last month. “We need job creation to start picking up to absorb the excess supply in the economy and get inflation sustainably back to target.”

Some measures of core inflation, which exclude volatile CPI movements, also cooled in July. The central bank’s preferred core inflation measures rose by an average of 2.7 percent on a three-month annualized basis, down from 2.9 percent in June.

Consumer prices increased by 0.4 percent from June to July, unadjusted for seasonality, with gasoline prices contributing significantly, rising by 2.4 percent during the month.

Grocery prices saw a 2.1 percent annual increase in July, consistent with June’s rise. These prices have moderated from peak increases of around 11 percent in late 2022 and early 2023.

On the other hand, some products are experiencing price reductions. For instance, the price of passenger vehicles dropped by 1.4 percent in July compared to the previous year, driven by a 5.7 percent decline in used car prices as inventories improve.

Shelter costs rose by 5.7 percent annually, down from 6.2 percent in June, marking the first time this reading fell below 6 percent since December. The decline in interest rates has eased mortgage interest costs, which, while still up by 21 percent year-over-year, have decreased from peak increases of around 30 percent in 2023.

However, many homeowners will be renewing their mortgages at higher interest rates over the next two years, a factor in the central bank’s discussions.

“There is a risk that consumer spending could be significantly weaker than expected in 2025 and 2026, given the number of households likely to be renewing their mortgage at higher rates,” noted a summary of deliberations for the Bank of Canada’s July rate cut.

To date, the Bank of Canada has lowered rates by a quarter-point at each of its last two decisions, bringing the benchmark lending rate down to 4.5 percent from 5 percent.

Mr. Macklem mentioned last month that the central bank is not on a “predetermined path,” but also stated that “it’s reasonable to expect further cuts” to the policy rate if inflation continues to subside as anticipated. The Bank of Canada forecasts an average annual inflation rate of 2.3 percent for the third quarter, expecting inflation to return to its 2 percent target next year.

“With inflation appearing to be under control, the Bank of Canada has more leeway to set policy in response to downside risks to the economy stemming from the rise in the unemployment rate,” wrote Andrew Grantham, senior economist at CIBC Capital Markets, in a report.