Canada: Inflation Drops In July

Headline CPI inflation declined to 1.3% y/y in July from 1.5% y/y in June (top chart). Core CPI inflation was also down to 1.7% y/y from 2.0% y/y a month before. On a monthly basis, headline CPI (-0.1%) and core inflation (-0.1%) were both down. On a seasonally adjusted basis, headline CPI was down 0.1% and core prices remained unchanged. Only 4 of the eight broad CPI categories saw increases (SA). There were notable price decreases for clothing and footwear (-0.9%) and transportation (-0.8%) and gains for food, household operations, and shelter. On a regional basis, 8 provinces experienced lower price pressures in July (y/y), the sharpest decline being observed in Newfounland & Labrador (from 2.2% to 1.6%).

OPINION: July's inflation report was much softer than consensus expectations due to a very tame core CPI. Over the last three months, core inflation is running at an- 0.3% annualized pace its lowest level since 2007. If we use the same definition of core inflation as in the U.S. (CPI excluding food & energy), the picture is even more deflationary with an annualized price decrease of 1.7% over that period. Such a development has not been observed since 1994 in Canada.. Weaknesses have been widespread with bigger-than-usual price drops in clothing & footwear, health & personal care and vehicles since April. That said, this recent situation seems overdone relative to economic fundamentals. As such, we expect core inflation to strengthen somewhat in the months ahead. Also, the recent surge in grain and gasoline prices will ultimately push up headline inflation. All in all, given actual concerns about the global economy and the tame inflation backdrop in Canada, the Bank of Canada’s\ tightening bias is increasingly looking untenable. Assuming an expected uptick in subsequent months, core inflation should averaged 1.5% in Q3, well below the BoC's 1.9% estimate for the quarter.