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Lowest Core Inflation Since 1999 Tests Canada Rate-Hike Talk

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Lowest Core Inflation Since 1999 Tests Canada Rate-Hike Talk

The Bank of Canada’s efforts to set the stage for a rate increase were set back Friday after data showed inflation pressures continuing to ease.

Canada’s consumer price index rose 1.3 percent in May from a year ago, the slowest pace this year, down from an annual pace of 1.6 percent in April, Statistics Canada said Friday from Ottawa. Another key gauge of price pressures that excludes gasoline and some other more volatile items fell to the lowest since 1999.

The inflation report undermines the case for a quick rate hike by the Bank of Canada even as the nation’s economy has been growing at a pace that is among the fastest in the developed world. Governor Stephen Poloz and his top deputy Carolyn Wilkins have begun to openly talk about the prospects of higher interest rates, fearing the acceleration in growth will fuel increases in prices and wages.

“We think prospects of a move next month have been dealt a blow today,” Josh Nye, an economist at Royal Bank of Canada, said in a note to investors.

The Canadian dollar fell on the report, losing 0.3 percent to C$1.3265 per U.S. dollar at 11:17 a.m. in Toronto. Yields on Canadian government two-year bonds fell to 0.9 percent, from 0.93 percent yesterday. Swaps trading suggests investors are putting a 33 percent probability of a rate hike at the Bank of Canada’s next rate decision July 12. That’s down from more than 50 percent earlier in the day.

Economists surveyed by Bloomberg had forecast inflation would slow to 1.5 percent from 1.6 percent in April on lower gasoline prices.

The Bank of Canada last week began to play down sluggish inflation numbers, arguing they were simply capturing the lagged effects of past excess capacity — suggesting it was turning its focus to growth and employment figures that show the economy has been running hot.

The economy accelerated to a 3.7 percent annualized pace in the first quarter, following gross-domestic-product gains of 2.7 percent and 4.2 percent in the prior two periods. That’s the strongest three-quarter gain since 2010.

But inflation numbers have disappointed. While a low inflation-high growth situation seems optimal, policy makers interpret sluggish price gains as signs of excess capacity in the economy. That’s why the Bank of Canada has an explicit mandate to keep inflation at about 2 percent, an objective it’s largely failed to deliver over the past five years.

Inflation for the first two months of the second quarter is averaging 1.5 percent, versus Bank of Canada forecasts of 1.7 percent.

Measures of annual core inflation, a key indicator tracked by the Bank of Canada that excludes volatile components such as gasoline, fell to the lowest in almost two decades. The average of the central bank’s three core measures declined to 1.3 percent, the lowest since March 1999.

Recent changes in electricity policy by Ontario Premier Kathleen Wynne’s government seem to be having an impact. Electricity prices in that province were down 16.1 percent year over year in May, bringing inflation down in Ontario to 1.4 percent from 1.9 percent in April.

The gap between goods and services inflation is widening. Price increases for services were 2.3 percent in May, compared with 0.1 percent for goods. The difference between the two rates was the widest since 2015.

Inflation has eased largely because of non-existent price gains for goods. Prices for services — which some economists believe may be a better gauge of how strongly a domestic economy is moving — are showing a different picture, with annual gains of 2.3 percent in May.

Services inflation “is a better indicator of domestic slack, and where underlying inflation trends are heading,” Nick Exarhos, an economist at Canadian Imperial Bank of Commerce, said in a note to investors.