May Inflation at 7.7% in Canada, Highest Level Since 1983; USD/CAD Holds Gains

CANADIAN INFLATION DATA:

• May Consumer Price Index rises 1.4% m-o-m, five tenths of a percent above estimates. The annual rate, for its part, surges to 7.7%, the highest level in nearly 40 years.
• Core inflation advances 0.8% m-o-m and 6.1% y-o-y, also topping expectations
• USD/CAD holds daily gains after the Canadian CPI report crosses the wires, but the move is linked to risk-off sentiment and falling oil prices

Most Read: Central Bank Watch – Bank of Canada, RBA, and RBNZ Interest Rate Expectations

Price pressures strengthened last month in Canada, bolstered by soaring energy and food costs, further eroding consumer purchasing power and increasing the risk of inflation becoming seriously entrenched in the economy, a situation that could lead to more aggressive monetary policy tightening in the coming months.

According to Statistics Canada, the consumer price index, which measures a comprehensive basket of goods and services, surged 1.4% on a monthly basis in May, bumping the annual reading to 7.7%, the highest level since January 1983, a figure almost four times the central bank's 2% target. Analysts surveyed by Bloomberg News had expected headline CPI to rise just 1.0% m-o-m and 7.4% y-o-y.

Details of the report showed that energy contributed the most to the monthly increase, as this category spiked 8.5% m-o-m on the back of a 12% m-o-m surge in gasoline. With prices at the pump rising further during the first half of June, energy expenditures will remain biased to the upside in the near-term, suggesting that the headline index may exceed 8% later in the year before topping out.

Core CPI, which excludes energy and food and tends to reduce transitory noise created by volatile items, climbed 0.8% m-o-m and 6.1% y-o-y. The annual rate was the hottest print since the series was introduced in 1999, a sign that price pressures are widespread and impacting even stickier components of the CPI basket.

Faced with broadening inflationary forces, the Bank of Canada may be inclined to continue to front-load interest rate increases at upcoming meetings in order to restore price stability, especially as the resilience of economic activity gives policymakers room to be aggressive, at least for now. Against this backdrop, BoC is likely to raise borrowing costs by 75 bps to 2.25% at its July gathering, delivering its biggest hike in 24 years.

BoC Governor Tiff Macklem said a few weeks ago that a benchmark interest rate of 3% or higher is not out of the question. Today's CPI report will likely reinforce expectations that the institution will have no choice but to move monetary policy into restrictive territory in its efforts to tame red-hot inflation.

A hawkish tightening cycle by BoC, similar to that of the Federal Reserve, will prevent yield differentials between U.S. and Canadian debt from widening, providing support for the Canadian dollar so long as sentiment improves and global markets stabilize.

USD/CAD held morning gains and traded near 1.2980 immediately after the Canadian CPI report crossed the wires, with the advance being attributed to risk-off mood and falling oil prices. Once risk appetite recovers, however, the Canadian dollar may be able to mount a moderate rebound against the greenback.

USD/CAD 3-MINUTE CHART

Source: TradingView

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---Written by Diego Colman, Market Strategist for DailyFX