Rising Gasoline Prices Power Surge in Canada's Inflation Rate

Canada's all-items inflation rate jumped to 3.1% in June, higher than market forecasts of 2.9%, to the fastest pace of increase since September 2005. The Bank of Canada's core inflation rate, CPIX, was 1.5%, slightly lower than the expected 1.6%.

The surge in the all-items inflation rate largely reflected a 26.9% rise in gasoline prices during the past 12 months. The big increase packed an even bigger punch because it came on top of a 4% decline in gasoline prices in June 2007. Excluding gasoline, consumer prices were 1.8% higher than a year earlier, up from May's 1.6%.

On the month, the all-items index rose 0.7% in June relative to May, faster than market forecasts for a 0.5% increase while the CPIX rose an as-expected 0.1% on the month. The monthly increase in the all-items index reflected higher energy prices with gasoline costs rising 5.8% and natural gas prices up 8.2%. Air transportation costs posted another hefty 6.7% gain on the back of May's 5.4% increase. Prices for food posted a solid 1% rise with fresh vegetable prices rising 6.1%. Lower prices for passenger vehicles (-0.5%) and men's clothing (-4.6%) had some moderating effect on the monthly change.

On a year-over-year basis, the biggest contributor to June's 3.1% rise was gasoline prices which stood 26.9% higher than in June 2007, a pick-up from the 15% year-over-year increase in May. Prices of other fuels also firmed, jumping 49.3% relative to a year earlier, the same rate as in May. Mortgage interest costs contributed to May's stronger-than-expected annual rise and were up 9%. Once again, homeowners' replacement costs posted a slightly slower pace of increase and were up 3.2%. Mitigating some of the impact of the price increases were lower prices for the purchase and lease of passenger vehicles (-8.4%), as manufacturers gave incentives on new models, with computer equipment prices posting a 13.2% decline.

Normally, a steady streak of higher inflation rates would be met with a resounding call that the Bank of Canada would raise interest rates. However last week's Monetary Policy Report Update silenced calls that the Bank would shift into rate hike mode as the Governor highlighted that the best predictor of the all-items inflation rate in the medium-term is movement in the core and today's report showed that the core rate stayed in the lower end of the range during the past year at 1.5% in June.

The Bank of Canada forecasts that the core inflation rate will remain below 2% through early 2009 as the growing slack in the economy contains the pick-up in core prices. Going forward, the Bank will remain wary about the impact of the rise in the headline rate on inflation expectations, which were characterized as "well anchored" in the central bank's July Report. Despite the somewhat hotter inflation environment, forecasts (both RBC and the Bank of Canada) that the economy will grow at a slower-than-potential rate suggest that the Bank will hold the policy rate at 3% for the remainder of the year.

RBC Financial Group
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The statements and statistics contained herein have been prepared by the Economics Department of RBC Financial Group based on information from sources considered to be reliable. We make no representation or warranty, express or implied, as to its accuracy or completeness. This report is for the information of investors and business persons and does not constitute an offer to sell or a solicitation to buy securities.