Core Inflation Uptick Backs Case for Second Canada Rate Hike

(Bloomberg) 

Canada’s core consumer prices and retail sales came in faster than expected, signaling that overall inflation may turn around to clear the way for another rate increase this year.

The average of the central bank’s three core inflation measures rose to 1.4 percent in June, Statistics Canada said Friday from Ottawa, up from a May reading of 1.3 percent that was the lowest since 1999. Retail sales doubled economist forecasts for May with a 0.6 percent increase, bringing the year-over-year gain to 7.3 percent, more than double the average over the last decade.

Canada’s dollar strengthened a fourth day as the reports lined up with Bank of Canada Governor Stephen Poloz’s argument that inflation will shrug off some temporary weakness and move back toward his 2 percent target over the next year. Poloz lifted the key rate to 0.75 percent this month, the first such move in seven years, and said further tightening depends on how fresh data changes the inflation outlook.

“Seeing the core measures trend up, that’s quite comforting for the bank,” Fred Demers, chief Canada macro strategist at TD Securities, said by phone from Toronto. The retail gain also puts the economy on track for another quarter of growth at faster than a 3 percent annualized pace, meaning another rate increase in October “is a very likely scenario,” he said.

The economy grew at a 3.7 percent pace in the first three months of the year, the kind of expansion Poloz has said will bring the country to full output around the end of this year.

Consumer Strength

Consumers encouraged by low interest rates and job creation are leading the charge. The third straight gain in retail sales was led by a 2.4 percent increase at motor vehicle and parts dealers. Sales volumes, a better guide to economic growth because it strips out price swings, are up 6.4 percent from a year earlier, the largest rise since 2010.

The momentum was enough for investors to look beyond the overall inflation rate falling to 1 percent in June, the slowest since October 2015. That’s because several key items the Bank of Canada identified as temporary sources of weakness firmed up in June.

Prices for energy fell 1.3 percent, and for automobiles declined 0.2 percent, the first drop since February 2015. The Bank of Canada estimated those two components shaved 0.7 percentage points off the inflation rate in the second quarter.

Food costs rose 0.6 percent, breaking a string of eight previous declines. The central bank has also said intense retail competition is holding down prices more than may be justified by a decline in the cost of agricultural products.

“We would absolutely not read the fact that headline missed consensus as jeopardizing normalization, not least with another solid retail sales report,” Jimmy Jean, a strategist in the fixed-income group at Desjardins Capital Markets in Montreal, wrote in a research note.

The Canadian dollar rose 0.4 percent to C$1.2536 per U.S. dollar at 11:38 a.m. Toronto time. Futures swaps trading also suggests investors have almost fully priced in another rate increase by December.

Two of the three core measures quickened in June. The ‘common’ core rate moved to 1.4 percent from 1.3 percent and ‘median’ core rate was 1.6 percent following a May reading of 1.5 percent. The ‘trim’ core rate was unchanged at 1.2 percent.

Faster core inflation “should be encouraging for the Bank of Canada and put all the CPI naysayers to rest for one month at least,”  Benjamin Reitzes, a Canadian rates and macro strategist at BMO Capital Markets, said by phone from Toronto. “On the retail sales, volumes were up 1.1 percent, that’s what counts.” The figures suggest the Bank can still raise interest rates in October, he said. “October is still a very reasonable call for the bank.”