MNI ANALYSIS: BOC Confidence Could Be Lifted By CPI, Sales

By Yali N'Diaye

     OTTAWA (MNI) - Canada's inflation and retail sales data beat expectations

Friday, and could reinforce the Bank of Canada's growing confidence in the need

to normalize interest rates.

     However, at this stage, the data do not justify an acceleration of rate

hikes in light of the central bank's projections, which include an expected

pickup in inflation once the impact from tariffs takes hold. Energy prices were

the key driver of the inflation boost in June.

--SIX-YEAR HIGH INFLATION

     The 12-month inflation rate picked up to 2.5% in June from 2.2% in May,

reaching its highest level since February 2012, Statistics Canada reported

Friday. As a result, second quarter inflation increased to 2.3% from 2.1% in the

first quarter, slightly above the BOC's 2.2% projection.

     A 24.6% 12-month gain in gasoline prices, the largest since June 2011, was

the main positive contributor. Excluding gasoline, inflation was 1.6%, up from

1.5%, but still below the 2.0% mid-range target.

--CORE MEASURE AT TARGET

     While food and energy were key drivers of the surge in the all-item CPI,

the index excluding these two items still accelerated to 1.8% from 1.7%.

     More importantly, the BOC's three preferred measures of core inflation did

remain at target, with the range still between 1.9% and 2.0%. However, while two

of the measures were at 1.9% in May and one at 2.0%, CPI-trim picked up to 2.0%

in June. As a result, both CPI-trim and CPI-median are now at 2.0%. 

--PROJECTED TEMPORARY ACCELERATION

     That being said, the BOC is expecting inflation to continue higher in the

short term, with a projection of 2.5% in the third and fourth quarters, citing

"temporary" pressure from rising gasoline prices and higher services prices

related to minimum wage hikes, as well as the exchange rate pass-through and the

impact of retaliatory tariffs on products imported from the U.S. Such tariffs

are expected to "temporarily" boost Canada's CPI by 0.1 percentage point until

the third quarter of 2019. Low food prices are expected to provide some negative

offset.

     Inflation should then return to around 2.0% from mid-2019, according to the

BOC.

     Friday's inflation data are thus likely to comfort its confidence, but do

not justify an acceleration in the pace of rate hikes beyond the current gradual

approach.

     Further tariffs or a prolonged U.S. dollar strengthening could, however,

alter that path and warrant monitoring.

--RETAIL SALES REBOUND

     On the activity side, retail sales rebounded more than expected in May,

when they recorded a 2.0% gain on widespread increases.

     While autos and gasoline stations sales were the main contributors, gains

were widespread across 8 of 11 subsectors representing 70% of retail trade.

     That being said, given that the weather had dampened sales in April, it

remains to be seen whether the performance will be sustained in June.

     Therefore, the May increase should comfort the BOC, but the central bank

will likely want to wait for more data points to assess the risk that household

consumption exceed its expectations as the growth composition shifts towards a

greater contribution from business investment and exports.

     Stronger consumption is indeed one of the key risks to the inflation

outlook.

--MNI Ottawa Bureau; +1 613 869-0916; email: yali.ndiaye@marketnews.com

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