Inflation Unexpectedly Hits 3% in Test for Bank of Canada

(Bloomberg) -- Canada’s inflation hit the 3 percent mark for the first time since 2011 in July, an unexpected surge that puts pressure on the Bank of Canada to accelerate interest-rate increases.

The consumer price index recorded an annual pace of 3 percent, quickening from 2.5 percent a month earlier, Statistics Canada said Friday from Ottawa. Economists expected the inflation rate to remain unchanged.

While there’s evidence the acceleration was led by temporary factors, the faster-than-expected results will test Bank of Canada Governor Stephen Poloz’s efforts to be careful about raising interest rates over the next year to avoid a disruption to the economy. Price gains have now reached the upper end of the central bank’s 1 percent to 3 percent inflation range, and Poloz has already raised borrowing costs four times since last year to cool the economy.

The Canadian dollar jumped on the report, gaining 0.7 percent to C$1.3070 per U.S. dollar at 8:52 a.m. in Toronto trading. Yields on Canadian government two-year bonds rose to 2.12 percent, from 2.08 percent Thursday.

Swaps trading suggests investors are anticipating as many as three more hikes over the next year, after which the central bank is expected to go into a long pause. Odds of a rate hike by October are fully priced in, with the odds of a move as early as the next meeting on Sept. 5 at about 30 percent.

At 1.5 percent, the central bank’s benchmark interest rate remains well below the 3 percent “neutral” rate the Bank of Canada estimates as a final resting place for borrowing costs.

Transitory?

One comfort for Poloz will be the increases last month reflected largely transitory gains, with underlying inflation little changed at about the central bank’s 2 percent target. In July, it was a surge in air transport and travel tour prices driving much of the acceleration.

Core measures of inflation -- seen by officials as a better gauge of whether or not the economy is overheating -- ticked up to an average of 2 percent from 1.97 percent in June. A 2 percent core rate is consistent with an economy at full capacity -- but not one that is overheating -- and is in line with the central bank’s estimates for underlying inflation to remain near its target even as overall price gains increase temporarily.

While today’s figures will “result in increased speculation that the Bank could hike again as early as September, we continue to lean toward October for the next move,” Andrew Grantham, an economist at CIBC in Toronto, wrote in a research note.

Yet, July’s 3 percent pace is more than the central bank has been anticipating and will test Poloz’s resolve to tolerate higher inflation. In its most recent forecasts released last month, the central bank estimated inflation would average 2.5 percent in the third quarter -- which begins in July -- before returning back to near the 2 percent target by 2019.

Gasoline prices -- up 0.8 percent in July and 25.4 percent from a year earlier -- have also been a main contributor to the recent acceleration in prices. Excluding gasoline, inflation would be 2.2 percent in July.

There was little effect from higher tariffs on consumer prices in July. Statistics Canada released a report on the estimated impacts of Canada’s tariffs on U.S. metal and consumer products and found there would only be a small overall increase -- with no more than a decimal point increase to inflation over a limited period of time.

Other CPI Highlights

• Monthly inflation was up 0.5 percent in July, versus analyst expectations for a 0.1 percent gain. On a seasonally adjusted basis, inflation was also up 0.5 percent, the biggest increase since January.
• The “common” and “median” core rates were unchanged at 1.9 percent and 2 percent, respectively. The “trim” rate rose to 2.1 percent from 2 percent.
• Inflation for services in July was 3.2 percent, the fastest pace since 2008. Goods inflation was 2.8 percent.
• Air transportation prices were up 16.4 percent during the month of July, with travel tour prices up 13.9 percent. Telephone services and electricity prices also acted as transitory impacts on July inflation.

--With assistance from Erik Hertzberg.

To contact the reporter on this story: Theophilos Argitis in Ottawa at targitis@bloomberg.net

To contact the editors responsible for this story: Theophilos Argitis at targitis@bloomberg.net, Greg Quinn

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