Could the inflation outlook complicate the BoC's path on rate cuts?

Inflationary pressures across the country are likely to continue easing in the months ahead – meaning the Bank of Canada is set to continue on its path of planned interest rate cuts, according to two Royal Bank of Canada (RBC) economists.

Nathan Janzen and Claire Fan wrote in their weekly preview that inflation has eased at a slower pace in recent months than before and is expected to hold steady in July at 2.7% (headline) and 2.9% (excluding food and energy measures) in Tuesday’s consumer price index (CPI) reading.

While shelter costs continue to play a significant role in driving inflation, this factor is showing signs of easing, the economists noted. This shift is largely due to declining interest rates, which have contributed to reduced mortgage interest costs. However, when excluding these mortgage costs, the CPI has aligned closely with the 2% inflation target since the start of the year.

Janzen and Fan highlighted that the Bank of Canada (BoC) is now more focused on future inflation trends rather than past data. The three-month rolling averages of the BoC's preferred core inflation measures, median and trim, which aim to filter out monthly fluctuations and offer a clearer view of underlying price trends, have seen a slight increase for the second consecutive month. Despite this, the annual rates for these measures are expected to continue decreasing, thanks to earlier weaker readings.

While initial interest rate reductions by the BoC raised concerns over a possible surge in housing prices, the actual market response to the recent 25-basis-point-cuts in June and July has been moderate, with indications of slowing rent increases.

The broader economic and labour landscape in Canada also hints at diminishing inflation pressures. The per-capita gross domestic product continues to decline in Q2, and the unemployment rate has risen nearly a percentage point from last year, impacting job availability and wage growth.

Governor Tiff Macklem of the BoC has expressed increased confidence in the ongoing reduction of inflation, though he acknowledges potential obstacles ahead. Janzen and Fan said 25-point cuts in the months ahead are likely, with September and October set to see rates drop.