Canada: Pain at the Pumps Drives Inflation in June

• Gas prices up 26.9% pushing headline inflation to 3.1%
• Core inflation stays at 1.5%

Today's CPI report confirmed what anyone who drives a car and has had to fuel it up already knew – gas prices are rising and it doesn't feel good. Led by a whopping 26.9% increase in gasoline prices, Canadian consumer prices rose by 3.1% from June of last year, the highest rate of increase since the Hurricane Katrina led spike in fuel prices in 2005. For consumers deciding to leave the car at home, inflation was a bit easier to take. Excluding gasoline, consumer prices rose by a more subdued 1.8%. The Bank of Canada's core inflation measure also remained contained, up 1.5% from a year-ago, the same rate as the previous month.

Unfortunately, even if you don't drive you still have to eat. Food prices, which until recently had remained quite soft thanks to the rising Canadian dollar and competition among grocers, have risen steadily for the past three months and are now up 2.8% from a year ago. Higher gas prices have also made it more expensive to fly, pushing up the cost of air-travel 14.3% from a year-ago. And while we can't blame this one on rising gas prices, mortgage interest costs also accelerated in June and are now up 9% from a year ago.

With June in the rear-view mirror, the question is where to from here? Our belief is that oil prices at the U.S. $145 a barrel mark reached at the beginning of this month overshot the world's ability to pay. In developed economies already struggling with slower economic growth, the added pressure of higher energy prices has led to significant demand destruction. Supply is likely to outpace demand through the remainder of this year, bringing oil prices back towards the U.S. $100 a barrel mark by the first quarter of 2009. In addition, the shelter component of CPI, which makes up close to 27% of the total consumer basket, will also begin to cool through the remainder of this year. Existing home prices actually retreated slightly in June and this will soon begin to show up in the new home price component of the CPI basket.

The hangover from higher energy prices will lead to an elevated rate of inflation through the remainder of this year. Headline inflation is expected to peak around 4.0% in the fourth quarter before moving back to earth through the remainder of 2009. As the Bank of Canada has recently recognized, the Canadian economy has moved into a state of excess supply. Canadian economic growth will likely perform below its potential growth rate through the first quarter of 2009, putting upward pressure on the unemployment rate and downward pressure on prices. With energy prices likely to ease through the course of this year, the worst of the inflation pest may now be behind us. If only we could say the same thing about flagging economic growth.

TD Bank Financial Group

The information contained in this report has been prepared for the information of our customers by TD Bank Financial Group. The information has been drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does TD Bank Financial Group assume any responsibility or liability.