Inflation in May accelerated past the top end of the Bank of Canada's target range, but economists say it has likely peaked and the 33 per cent jump in gas prices masks an economy still struggling for footing.
Inflation spikes above target range
The consumer price index (CPI) rose to 3.2 per cent in May year over year from 2.8 per cent in April, above the central bank's target range of one per cent to three per cent, Statistics Canada said on Monday. However, economists argue that the headline figure is misleading due to the outsized impact of energy costs.
Andrew Grantham, an economist at CIBC Capital Markets, said in a note, "With oil and gasoline prices now well off their previous highs, this should prove to be the peak and, as such, viewed as old news." Excluding gasoline, inflation would have been 2.2 per cent, though that is still higher than the two per cent recorded in April, partly due to a jump in vacation tour prices and airfares on higher fuel charges.
Core inflation and economic weakness
The Bank of Canada prefers to focus on core inflation measures, but Grantham warned that core inflation could rise over the next few months due to summer travel and the World Cup. Despite this, CIBC expects policymakers will hold rates for the rest of the year.
Ali Jaffery, chief economist at KPMG Economics, noted that "inflation moved higher again primarily on energy and energy-related items and rising food prices." He said the increase in food prices was in line with that category's trend, mostly attributed to bananas and tomatoes. Statistics Canada reported that tomato prices rose 45.2 per cent in May as supply from Mexico was hit by a drought and higher transport costs.
Weak economy and consumer strain
Jaffery emphasized that otherwise, inflation continues to prove Canada's economy is weak and suffering from excessive slack, meaning it has the capacity to produce more than it currently is. He said the pass-through from higher energy prices isn't as broad as it could be, as evidenced by weaker rental inflation, falling home prices, and weaker price growth on items such as clothing and appliances.
"Businesses just aren't in a position to quickly pass on higher costs to a stretched Canadian consumer, particularly when there are also fewer of them, with the population declining this year," Jaffery said. He predicted "margin compression" will continue forcing companies to pause any expansion plans.
"The Bank of Canada can live with headline inflation elevated in a range of 2.5 per cent to three per cent, so long as core inflation remains around where it is, the economy looks soft and businesses' expectations about future price increases aren't excessive," he said.
