Inflation rises in Canada. Could a rate hike follow?

Executive summary:

Headline inflation increases at 4.4% clip in Canada
U.S. retail sales rebound, while manufacturing struggles
Signs of progress emerge in U.S. debt-ceiling negotiations

On the latest edition of Market Week in Review, Investment Strategy Analyst BeiChen Lin and ESG and Active Ownership Analyst Zoe Warganz discussed the latest inflation data from Canada and whether it could impact the Bank of Canada (BoC)’s current pause on interest-rate increases. They also reviewed recent U.S. economic data and provided an update on the latest negotiations over the U.S. debt ceiling.

Consumer prices rise unexpectedly in Canada

Warganz and Lin kicked off the segment by unpacking the latest consumer price index (CPI) numbers from Canada. Lin said that contrary to expectations, headline CPI rose at a 4.4% clip in April on a year-over-year basis - a slight acceleration from March’s increase of 4.3%. The uptick was largely due to higher gasoline prices, he noted.

Lin explained that the three core inflation measures preferred by the BoC - CPI-trim, CPI-median and CPI-common - actually slowed down in April compared to March, on a year-over-year basis. This illustrates how inflation does not necessarily decline linearly, he said. “Slowing inflation may consist of a series of declines, with an occasional spike back up. It’s never going to be a linear process all the way down,” Lin remarked.

Warganz asked Lin if the uptick in headline inflation could have any impact on the BoC’s conditional rate pause, which officials announced earlier this year. Lin said that while markets are now anticipating that the bank might have to deviate from this pause at some point in the year, one month of data is not sufficient enough to base a decision on.

“The BoC is going to be looking at a variety of data before making any determination on rates, and whatever decision it ultimately makes will be made very carefully. Now, there are some measures that point to the Canadian economy still being quite resilient - for instance, home prices in April rose by 1.6% on a month-over-month basis. However, there’s still plenty of time this year for economic indicators like this to change,” he explained.

Ultimately, Lin doesn’t expect the BoC to raise rates at its next meeting in early June. “I anticipate that the bank will stay on hold,” he said, emphasising that above all else, BoC leaders will continue carefully monitoring the latest data.

More mixed signals for the U.S. economy

Turning to the U.S., Lin characterised the latest batch of economic data as a mixed bag. On the one hand, U.S. retail sales rebounded in April after a slowdown in March, he said. On the other hand, recent manufacturing data from the Philadelphia Fed and Empire State surveys showed ongoing weakness in the sector, Lin stated, noting that both surveys indicated contractionary conditions.

“The bottom line here is that we’re seeing mixed signals pertaining to the U.S. economy. And it’s important to understand that in real life, this is often the case. Understanding what the data is telling you requires really parsing through all of the signals,” he remarked.

Lin said that overall, he still expects that the U.S. economy will slow down sometime in the next 12-18 months, with a recession potentially developing. However, any recession will likely be mild to moderate in scope, he noted, stressing that investors should stay calm and disciplined.

Negotiations over U.S. borrowing limit continue

Lin and Warganz finished the segment with an update on the progress of negotiations to raise the debt ceiling limit in the U.S. Congress. Lin noted that House Speaker Kevin McCarthy expressed optimism on the potential for an agreement to be struck among lawmakers soon - possibly in a matter of days. If this proves to be the case, the House of Representatives may be able to vote on a deal as soon as early in the week of 22 May 2023, he said.

However, Lin cautioned that in politics, things can easily change at the last minute. Until a deal is passed, the situation bears close watching, he remarked. At the end of the day, however, it’s pretty clear that no lawmaker - whether Republican or Democrat - wants the U.S. to default, Lin said.

“I believe that all politicians recognise the importance of preserving the full faith and credit of the United States, and that ultimately, they will do the right thing,” he concluded.

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Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice