US and Canadian Economic Update

Upcoming Canadian Inflation Release Preoccupies Markets

With all quiet on the Canadian data front, market focus turns sharply towards Friday’s June consumer price (CPI) release.  This release will complete the second quarter and will give observers an opportunity to see if inflation remained at the Bank of Canada’s 1.8% year-over-year projection for the core rate (CPIX) in the quarter.  RBC Economics expects that the core rate will grow at a 2.2% year-over-year clip in June.

Traveler’s accommodation prices rose sharply May supporting the month’s outsized monthly increase.  Historically, these prices have tended to grow again in June, albeit at a slower pace than in May.  The homeowner’s replacement cost part of the index likely increased in June as the new house price index surged 1.3% in May on the back of April’s large 1.2% gain.  Until May’s sizzling data, April’s month-over-month gain had been the largest since March 1989.

Gas prices probably didn’t add much to the month-over-month growth in the all-items index; however, on a year-over-year basis, they likely made a significant contribution.  The projected rise in the year-over-year rate in the CPIX to 2.2% would be the fastest pace of increase in this index since May 2003 and would leave the second-quarter average at 1.9%, slightly above the Bank of Canada’s 1.8% forecast.

U.S. producer Price Index Rises More than Expected

The producer price index (PPI) rose by a faster-than-expected0.5% in June, while the core PPI rose 0.2%, in line with the consensus forecast. The above-consensus reading on all-items PPI will likely keep Treasuries under pressure, although the as-expected core reading will likely limit losses. The report will be positive for the U.S. dollar since it keeps expectations of an additional Fed rate increase in play.

The 0.2% rise in the core finished PPI translated into a 1.9% year-over-year gain, up from1.6% in May, and the fastest pace of increase since October 2005. Core intermediate and crude PPI rose by 7.3% and 33.2%, respectively, on a year-over year basis.

The core crude PPI has risen at a progressively higher pace since October 2005 and the core intermediate PPI has jumped up during the past two months, adding some weight to the message that inflationary pressures at the earlier stages of production are building. The larger-than-expected increase in the all-items index reflected a 1.4% rise in the cost of food, while energy prices rose 0.7% and were up 19.1% from a year ago.

While today's PPI report raises the risk of another rate increase at the upcoming meeting, the focus will be on tomorrow’s release of June CPI and housing starts to fill in the growth/inflation picture for the second quarter. The Fed has indicated that interest rate policy is linked to the outlook for both economic growth and inflation and even if the core CPI rises in June, as we expect, indications that the economy slowed to about a 3% pace in the second quarter following the rapid 5.6% expansion in the first quarter may be enough to convince policymakers to step to the sidelines temporarily.

A high-side reading on the core consumer inflation rate would keep the risks to this view to the upside for rates but we continue to believe that the Fed will prefer to pause in August and assess the impact that past interest rate increases are having on economic growth.

Data Details

• Core crude PPI rose 33.2% on a year-over-year basis in June compared 26.8% in May.
• Core intermediate PPI rose 7.3% on a year-over-year basis compared May’s 6.3% print.
• Core finished PPI rose 1.9% on a year-over-year basis, the fastest pace of increase since October 2005.

To view charts of today's data, go to:

http://www.rbc.com/economics/html_calendars/ca/calendar.html  (Canada)
http://www.rbc.com/economics/html_calendars/us/calendar.html (United States)