Last Updated on July 26, 2024 by CREW Editorial
A July Edge Realty Analytics report noted that inflation data for May, which led to market turmoil due to what appeared to be a surprisingly strong inflation reading, may have been misleading. The Consumer Price Index (CPI) came in at 2.9% year-over-year (y/y), exceeding expectations of 2.6%. This prompted headlines suggesting an unexpected surge in inflation and led markets to wonder about the odds of a July rate cut. The prevailing sentiment was: with inflation seemingly surging, how could the Bank of Canada consider cutting rates?
The Overlooked Statistical Adjustment
However, a critical detail was overlooked. Statistics Canada periodically updates the composition of the Consumer Price Index (CPI) basket to reflect changing consumer spending patterns. This adjustment introduces volatility into CPI readings, as it changes the way information is calculated from one month to the next. Significantly, the basket of goods and services used in the calculation of the CPI was updated with the release of the May 2024 data.
The Edge Realty Analytics report indicates that, in the latest release, the mortgage interest component of the CPI basket was set to jump from 3.5% to 5.2%. Over the long term, this change will put more downward pressure on inflation as the Bank of Canada continues to cut rates. However, for May specifically, this adjustment meant that mortgage interest costs alone added 1.3 percentage points to the headline CPI.
Source: Edge Realty Analytics
Impact on Inflation Readings
This adjustment had a significant impact on the May CPI reading. Specifically, the increase in the mortgage interest component added 1.3 percentage points to the headline CPI. Therefore, of the reported 2.9% inflation:
- 1.3% was due to mortgage interest costs.
- 1.6% was attributable to all other components.
Data Interpretation
If the mortgage interest component is excluded, the underlying inflation rate is actually 1.6%. Considering that the Bank of Canada has direct control over interest rates, the report suggests that it is unlikely that the BOC is concerned about inflation at this degree. It further suggests that the perception of a surprisingly hot inflation rate was largely due to the change in how inflation is calculated – a statistical matter, not a genuine surge in inflation.
The report indicates that, as a result, the May CPI reading did not change the fundamental inflation outlook. Until there is sustained high inflation over several months, it is unlikely the Bank of Canada will deviate from its current path of rate cuts.
