Canadian Inflation Surged to 7.7% In May

Canada’s consumer price index increased 7.7% in May from a year earlier, up from 6.8% in April, the fastest inflation pace since January 1983. The release confirms that the Bank of Canada is staring down the most dangerous burst of Inflation since it started targeting the consumer price index in the early 1990s.

Excluding gasoline, the CPI rose 6.3% year over year in May, after a 5.8% increase in April. Price pressures continued to be broad-based, pinching the pocketbooks of Canadians and, in some cases affecting their ability to meet day-to-day expenses.

The acceleration in May was mainly due to higher gasoline prices, which rose 12.0% compared with April 2022 (-0.7%). Higher service prices, such as hotels and restaurants, also contributed to the increase. Food prices and shelter costs remained elevated in May as price growth was unchanged year-over-year.

Monthly, the CPI rose 1.4% in May, following a 0.6% increase in April. On a seasonally adjusted monthly basis, the CPI was up 1.1%, the fastest pace since the introduction of the series in 1992.

Wage data from the Labour Force Survey found that average hourly wages rose 3.9% year over year in May, meaning that, on average, prices rose faster than wages in the previous 12 months.

Energy prices rose 34.8% on a year-over-year basis in May, driven primarily by the most significant one-month price increase since January 2003. Compared with May 2021, consumers paid 48.0% more for gasoline in May, stemming from high crude oil prices, which also resulted in higher fuel prices (+95.1%).

Crude oil prices rose in May due to supply uncertainty amid Russia’s invasion of Ukraine, as well as higher demand as travel continued to grow in response to eased COVID-19 restrictions.

Grocery prices remained elevated in May as prices for food purchased from stores rose 9.7%, matching the gain in April. With price increases across nearly all food products, Canadians reported food as the area in which they were most affected by rising prices. Supply chain disruptions and higher transportation and input costs continued to put upward pressure on prices.

In May, shelter costs rose 7.4% year over year, matching the increase in April. Year over year, homeowners’ replacement costs rose to a lesser extent in May (+11.1%) compared with April (+13.0%), as prices for new homes showed signs of cooling.

Although prices for mortgage interest costs continued to decrease on a year-over-year basis, prices fell less in May (-2.7%) compared with April (-4.4%), putting upward pressure on the headline CPI.

Bottom Line

All central banks worldwide (except Japan) face much more than expected inflation. Today’s 7.7% inflation report for May increases the urgency for the Bank of Canada to quickly withdraw stimulus from an overheating economy for fear of price pressures becoming entrenched in inflation expectations and the economy. Tapping on the brakes isn’t good enough. The Bank must expedite the return to a neutral level of interest rates, which likely means the top of the neutral range at 3% for the overnight rate. It currently stands at only 1.5%.

We expect a 75 basis point hike on July 13, bringing the policy rate up to 2.25%. Markets are currently predicting that rate to go to 3.5% by yearend. That might well be too high, but right now, the Bank needs to prove its inflation-fighting credibility, even if it drives the economy into recession. It will continue to slow the housing market, reversing some of the 50% increase in national home prices over the past three years.

According to Bloomberg News, Senior Deputy Governor Carolyn Rogers was asked today about the possibility of a ‘super-sized’ move. She said, “We’ve been clear all along the economy is in excess demand, inflation is too high, rates need to go up. We’ll get it there.” Suggesting the possibility of an even larger than 75 bp rate hike.

The 7.7% annual reading may not even represent the peak, given that gasoline prices have picked up further in June.

The full range of core inflation measures surged in May, suggesting that price pressures go well beyond food and energy. The chart above shows that the Bank of Canada has consistently underestimated inflation. So have other central banks. They are bringing out the big guns now, and the housing market will always take the biggest hit.

Canadian Labour Market Is Much Too Tight–Adds To Inflation Pressure

Today’s Labour Market Survey for May 2022 showed that hiring continued at a rapid pace last month in an increasingly tight labour market, driving the jobless rate to another record low and fueling a sharp acceleration in wage gains. The economy added 39,000 jobs in May, surpassing expectations. The unemployment rate fell to 5.1%, far below the noninflationary rate of joblessness. Job vacancies are at a record high, and wage inflation accelerated to 3.9%, from the 3.2% pace posted in April.

Another sign of a red-hot jobs market was a shift from part-time employment to full-time. Full-time employment jumped by 135,400, with part-time jobs down by 95,800.

The excess supply of jobs continues to push wages higher and will undoubtedly cause the Bank of Canada to continue to hike rates aggressively. The Governing Council of the Bank will release their next decision on July 13, as money market traders now see an even chance that the central bank will increase the overnight policy rate by 75 bps next month.

The employment rate, which measures the percentage of the population aged 15 years and older that has a job, increased to almost 62% in May, from 59.4% cent a year earlier.

Bottom Line 

In other relevant news today, the US released its CPI inflation report for May showing inflation accelerated to a whopping 8.6%, up from 8.3% in April. Investors increased bets on a 75 bp hike after the release showing inflation is at a fresh 40-year high. Both headline and core inflation rose more than expected.

Market rates shot up on today’s news, with the Canadian 5-year government bond yield now at 3.3%.

The Bank of Canada Hikes Rates Again By 50 bps.

Another Jumbo Rate Hike, Signalling More To Come

The Governing Council of the Bank of Canada raised the overnight policy rate by a full 50 basis points once again today, marking the third rate hike this year. The two back-to-back half-point increases are without precedent, but so were the dramatic pandemic rate cuts in the spring of 2020. Indeed, with the surge in Canadian inflation to 6.8% in April, the Bank of Canada is still behind the curve. The chart below shows that inflation remains well above the Bank’s forecasts. Today’s press release suggests they now estimate that inflation rose again in May and could well accelerate further.

Today’s policy statement emphasized that “As pervasive input price pressures feed through into consumer prices, inflation continues to broaden, with core measures of inflation ranging between 3.2% and 5.1%. Almost 70% of CPI categories now show inflation above 3%. The risk of elevated inflation becoming entrenched has risen. The Bank will use its monetary policy tools to return inflation to target and keep inflation expectations well anchored.”

“The increase in global inflation is occurring as the global economy slows. The Russian invasion of Ukraine, China’s COVID-related lockdowns, and ongoing supply disruptions are all weighing on activity and boosting inflation. The war has increased uncertainty and is putting further upward pressure on prices for energy and agricultural commodities. This is dampening the outlook, particularly in Europe. In the United States, private domestic demand remains robust, despite the economy contracting in the first quarter of 2022.”

The Bank said that “Canadian economic activity is strong and the economy is clearly operating in excess demand. National accounts data for the first quarter of 2022 showed GDP growth of 3.1 percent, in line with the Bank’s April Monetary Policy Report (MPR) projection. Job vacancies are elevated, companies are reporting widespread labour shortages, and wage growth has been picking up and broadening across sectors. Housing market activity is moderating from exceptionally high levels. With consumer spending in Canada remaining robust and exports anticipated to strengthen, growth in the second quarter is expected to be solid”.

Bottom Line

The Bank of Canada couldn’t be more forthright. The concluding paragraph of the policy statement is as follows: “With the economy in excess demand, and inflation persisting well above target and expected to move higher in the near term, the Governing Council continues to judge that interest rates will need to rise further. The policy interest rate remains the Bank’s primary monetary policy instrument, with quantitative tightening acting as a complementary tool. The pace of further increases in the policy rate will be guided by the Bank’s ongoing assessment of the economy and inflation, and the Governing Council is prepared to act more forcefully if needed to meet its commitment to achieve the 2% inflation target.”

The Bank of Canada has told us we should expect at least another 50 bps rate hike when they meet again on July 13. It could even be 75 bps if inflation shows no sign of decelerating. The Bank estimates that the overnight rate’s neutral (noninflationary) level is  2%-to-3%. Traders currently expect the policy rate to end the year at roughly 3%.

This was a very hawkish policy statement. The central bank is defending its credibility and will undoubtedly continue to tighten monetary policy aggressively.