Consumer prices in Canada took an unexpected turn in May, rising after showing signs of cooling since the start of the year. This has forced markets to trim their expectations of a rate cut by the Bank of Canada in July to below 50 percent.
The Bank of Canada, which cut interest rates for the first time in four years earlier this month, has maintained that the path towards further easing would be data-dependent. However, May’s inflation data has dampened the chances of an immediate rate cut.
Acceleration in inflation rates
“This is not what the Bank of Canada wanted to see at this point, and clearly shaves the odds of a follow-up July rate cut,” said Douglas Porter, chief economist at BMO Capital Markets. He added that the next rate cut is likely to come in September.
The annual inflation rate accelerated to 2.9 percent in May from 2.7 percent in April, while key measures of core inflation – closely tracked by the central bank – also edged up for the first time in five months, according to Statistics Canada.
Market reaction and the Canadian dollar
As a result, money markets have heavily trimmed their bets and now see only a 45 percent chance of a rate cut in July, down from over 70 percent seen on Monday. The Canadian dollar also pared early losses, firming by 0.07 percent to 1.3663 against the U.S. dollar.
Analysts had forecast inflation to cool to 2.6 percent, but the surprise acceleration was driven by prices for services such as cellular services, travel tours, rent, and air transportation.
Read more: Bank of Canada lowers key interest rates to 4.75 percent, marking first cut in four years
Potential timing of next rate cut
“We suspect an abundance of caution will see the next move land in September, matching the timing of the first rate cut from the Federal Reserve,” said Karl Schamotta, chief market strategist at Corpay.
The Bank of Canada’s next meeting is scheduled for July 24, and it will have the benefit of one more inflation reading, along with the GDP number for May and jobs report for June, before making its decision.
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