Canadian Core Inflation Rate Popped Up to 2.1% in August

• Canada’s headline consumer price index was unchanged in August 2014 relative to July, which was in line with expectations.
• Prices were 2.1% higher than a year earlier, thereby matching July’s pace.
• The Bank of Canada’s core measure jumped by 0.5%, thereby beating market expectations for a 0.3% increase.
• The annual core rate popped to 2.1% from 1.7% in July.
• Despite the recent shift in inflation toward the mid-point of the Bank’s 1% to 3% target band, this week’s speech by the Governor suggested that monetary policy remains in neutral. Earlier this month, policymakers reiterated the view that the recent increase in inflation reflects temporary and sector-specific shocks that will dissipate in time. While recent data have diminished the downside risks to the inflation outlook, the Bank still needs to be convinced that the economy is growing quickly enough to ensure that the inflation rate does not revisit the lower bound any time soon.
• Other data point to the economy posting another above-potential gain in the third quarter of 2014 with this week’s report on manufacturing sales showing a substantive increase in July that tees up for a solid rise in real gross domestic product (GDP). Housing activity and car sales in August continued the strong trend. These reports are generating upside risks to the Bank of Canada’s forecast that real GDP will post a 2.3% annualized gain in the third quarter following a faster than expected 3.1% increase in the second quarter. The stronger than expected gains are also consistent with a narrower output gap at the end of the third quarter than the Bank envisioned and the elimination of spare capacity occurring earlier than was expected. To be sure, the Bank will have the opportunity to incorporate this data in its forecast update in October. Today’s data add to the growing list of indicators showing the economy does not need additional stimulus and justifying a shift in the Bank’s policy bias toward tightening. If current trends in growth, inflation, and the currency continue, then the Bank may use the October press statement and Monetary Policy Report to adjust its policy bias.

The unadjusted all-items Canadian consumer price index (CPI) index held steady in August 2014, which was in line with market expectations. The year-over-year inflation rate also was unchanged at 2.1%. Of the major components, three declined in August while five posted gains. The largest increase came in the household operations, furnishings, and equipment where prices rose by 1.0% relative to July, largely reflecting the 3.7% jump in telephone services. Alcohol and tobacco prices posted a large 0.9% monthly increase while recreation and entertainment costs rose by 0.5%. The details showed prices for telephone services, passenger vehicles, traveller accommodation, women’s clothing, and internet access posted increases in August that were offset by declining prices for gasoline, fresh fruit and vegetables, and natural gas.

The Bank of Canada’s core CPI measure posted a monthly 0.5% gain, which was larger than market expectations for a 0.3% increase. The rise in the unadjusted index mainly reflected higher prices for household operations and travel services. The year-over-year core rate hit 2.1% in August, which was the fastest pace of increase since April 2012. On a seasonally adjusted basis, the headline CPI rose by 0.1% while the core index posted a 0.2% gain.

Canada’s inflation rate stayed above 2% in August for the fifth consecutive month and averaged 2.1% so far in the third quarter. The headline rate is tracking slightly higher than the Bank of Canada’s forecast for a 2.0% average increase in the third quarter. The decline in energy costs of 0.6% in July and 2.1% in August pushed the year-over-year rate downward to 3.3%. Excluding energy, inflation pressures have been progressively rising with this measure 2.0% higher than in August 2013, and 46% of the components of the CPI posted gains of 2% or more. The core inflation rate appears to have graduated to a higher range as well in averaging 1.9% in July and August, which was above the second quarter of 2014’s 1.7% average and following a 21-month period when the measure did not breach 1.5%.

Despite the recent shift in inflation toward the mid-point of the Bank’s 1% to 3% target band, this week’s speech by the Governor suggested that monetary policy remains in neutral. Earlier this month, policymakers reiterated the view that the recent increase in inflation reflects temporary and sector-specific shocks that will dissipate over time. While recent data have diminished the downside risks to the inflation outlook, the Bank still needs to be convinced that the economy is growing quickly enough to ensure that the inflation rate does not revisit the lower bound any time soon.

Other data point to the economy posting another above-potential gain in the third quarter of 2014 with this week’s report on manufacturing sales showing a substantive increase in July that tees up for a solid rise in real GDP. Housing activity in August continued the strong trend. These reports are generating upside risks to the Bank of Canada’s forecast that real GDP will post a 2.3% annualized gain in the third quarter following a faster than expected 3.1% increase in the second quarter. The stronger than expected gains are also consistent with a narrower output gap at the end of the third quarter than the Bank envisioned and the elimination of spare capacity occurring earlier than was expected. To be sure, the Bank will have the opportunity to incorporate this data in its forecast update in October. Today’s data add to the growing list of indicators showing that the economy does not need additional stimulus and justifying a shift in the Bank’s policy bias toward tightening. If current trends in growth, inflation, and the currency continue, then the Bank may use the October press statement and Monetary Policy Report to adjust its policy bias.

Information contained in this report has been prepared by the Economics Department of RBC Financial Group based on information obtained from sources considered to be reliable. While every effort has been made to ensure accuracy and completeness, RBC Financial Group makes no such representation or warranty, express or implied. This report is for information purposes only and does not constitute an offer to sell or a solicitation to buy securities.

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