Policy-driven inflation

A nasty little surprise in the latest Canadian inflation data this morning. Statistics Canada reported that headline CPI rose 4.4 percent in the year to April, up from 4.3 percent in March. That's above the consensus expectation for a 4.1 percent rise and marks the first time year-on-year inflation has moved higher since June 2022. There is quite a lot to get confused about in today's numbers, not least because the main factors driving the annual rate are currently not the same as those driving monthly changes; let's try to keep things straight. 

We can start with a quote from the StatsCan press release regarding the annual headline number:  On a year-over-year basis, higher rent prices and mortgage interest costs contributed the most to the all-items CPI increase in April 2023. In other words, the single greatest contributor to the rise in prices over the past twelve months seems to be the Bank of Canada's rate hikes. That doesn't mean that shelter costs are the fastest-growing sub-component of the index; that dubious honour still belongs to food prices, which rose 8.3 percent from a year ago, compared to 4.9 percent for shelter. However, the weighting of the index means that shelter contributed the most to the annual headline increase.

If we now turn to the monthly numbers, we see a somewhat different picture, but one that offers little comfort for the Bank of Canada. Seasonally adjusted CPI rose 0.6 percent in April, a number which annualizes to well over 7 percent, far above the Bank's 2 percent target.  The biggest contributor to the monthly increase was the price of gasoline, which jumped 6.3 percent in the month, although it remains 7.7 percent lower than in April 2022. StatsCan cites the recent OPEC production cut as a key factor behind the increase and also mentions "an increase in carbon levies", specifically an increase in the much-despised Federal carbon tax that was imposed at the start of the month. The impact of the OPEC move has already proven to be largely transitory, but the tax increase will, of course, stay in place.

All of this adds up to a conundrum for the Bank of Canada. It can take some small comfort in the fact that its three "preferred" measures of underlying inflation all eased in the month, although their mean value remains above 5 percent. However, the fact that the monthly increase in April was so substantial makes it less likely that its earlier forecast that CPI will fall to 3 percent around mid-year will be realized. Markets are starting to price in a growing possibility of a 25 basis point rate hike at the next Governing Council meeting on June 7. For the moment that is not the likeliest outcome, but any more inflation numbers like today's will put the Bank's "conditional" pause under greater threat.