Underlying inflation pressures easing

The fall in headline inflation to 7.0% in August, from 7.6%, was largely due to energy price effects, but there were also some encouraging signs that underlying inflationary pressures are easing. The number of individual CPI components that rose by more than 2% annualised month-over-month dropped back to the pre-pandemic norm and the average of the Bank of Canada’s three core inflation measures declined for the first time since December 2020. The moderation of firms’ selling price expectations is another sign that core inflation has peaked. Admittedly, core inflation is likely to remain above 5% for the rest of the year and the Bank is concerned about the inflationary impact of the weakening exchange rate, so it is too soon for policymakers to declare victory. The Bank now looks set to raise its policy rate to a peak of 4.0%, which means that a drop in GDP in the coming quarters will be hard to avoid. But easing inflationary pressures at least mean that the Bank will have more flexibility than many of its peers to begin loosening policy next year.