Canada's annual inflation rate accelerated for the second month in a row in August, increasing 4 per cent as the price of gasoline surged and raising the odds of another Bank of Canada rate hike.
Still, with more economic data to come before the central bank makes its next interest rate decision in October, economists say the increase in the Consumer Price Index (CPI) won't bring the Bank of Canada off the sidelines yet when it comes to rate hikes.
Statistics Canada said the increase in CPI was largely driven by rising gas prices. Gas prices jumped 0.8 per cent in August, the first year-over-year increase since January, driven in part by base-year effects as prices fell during the same month in 2022.
On a monthly basis, CPI increased 0.4 per cent in August, a slowdown from July’s monthly gain of 0.6 per cent. Seasonally adjusted, CPI increased 0.6 per cent.
The increase in CPI is more than the 3.8 per cent economists expected, and above the Bank of Canada's 2 per cent target. The Bank of Canada held its benchmark rate steady at 5 per cent earlier this month, but left the door open to further hikes if inflation pressures persist.
Money markets raised bets for a rate hike in October after Tuesday's data release, placing a 42 per cent chance of another rate increase, versus 23 per cent odds before the release.
"Expectations for more tightening from the Bank of Canada have shot up since this morning's hotter-than-anticipated inflation report, with at least one hike priced in by the March meeting in early 2024," Corpay chief market strategist Karl Schamotta wrote in a research note on Tuesday.
But some economists say the increase in CPI will not spur the central bank to hike rates again. There will be additional economic data releases, including CPI for September, before the central bank issues its next rate decision on Oct. 25.
"Given that the economy stalled in the second quarter and labour market conditions have cooled off in each of the past five months, we continue to expect the central bank to take a very cautious approach to raising rates any further," Royce Mendes, Desjardins' managing director and head of macro strategy, wrote in a research note on Tuesday.
"Each month that passes, roughly 2 per cent of mortgage holders face renewal at sharply higher interest rates. The heavy debt load Canadians carry makes that a daunting prospect for policymakers."
What drove inflation higher in August
Higher rent and mortgage interest costs contributed to the August rise in CPI as shelter prices jumped 6 per cent annually, up from July's 5.1 per cent increase. The increase was led by the rent index, which increased 6.5 per cent annually compared to a gain of 5.5 per cent in July.
Alberta faced the biggest increase in energy prices, with costs jumping 13.3 per cent annually, as natural gas and electricity price gains contributed to the increase.
Moderating the rise in energy and shelter prices were declines in the cost of travel-related services and a smaller rise in food prices. While food prices have remained stubbornly high in Canada, the cost of food purchased from grocery stores increased 6.9 per cent year-over-year in August, a moderation from the 8.5 per cent increase recorded in July. On a monthly basis, grocery prices were down 0.4 per cent.
Two of the Bank of Canada's three closely watched core measures of underlying inflation posted gains. CPI-median edged up to 4.1 per cent from 3.9 per cent in July, while CPI-trim rose to 3.9 per cent from 3.6 per cent.
"Core inflationary pressures remained stronger than the Bank of Canada would like to see, although we still suspect that evidence of a slowing economy and rising unemployment rate will give policymakers enough comfort that inflation will ease ahead without the need for further interest rate increases," CIBC economist Andrew Grantham wrote in a research note on Tuesday.
Bank of Canada faces some tough decisions
The central bank flagged earlier in September that inflation would be higher in the near term due to recent increases in gasoline prices. With oil prices continuing to rise through September, Grantham noted that "inflation is more likely to accelerate slightly further than decelerate."
"(Underlying) inflationary pressures are also firmer than the Bank was probably expecting, meaning that policymakers will face some tough decisions at upcoming meetings," Grantham said.
"If consumer spending remains sluggish and the unemployment rate continues to grind higher as we forecast, we still expect that the Bank will refrain from further interest rate hikes despite the strong current inflationary backdrop."
According to Capital Economics, oil prices would need to settle near US$100 per barrel for the Bank of Canada to hike rates to contain inflationary pressures.
In its latest interest rate decision the Bank of Canada repeated its commitment to fighting inflation.
"Governing Council remains concerned about the persistence of underlying inflationary pressures, and is prepared to increase the policy interest rate further if needed," it said in September.
"Things just got a lot more interesting for the Bank of Canada, and most definitely not in a good way," BMO chief economist Douglas Porter wrote in a note.
"Unfortunately, we suspect that with oil firing higher and core inflamed again, that (September CPI) report will be no better than today's—second verse, same as the first, a little bit louder and likely a little bit worse."
With files from Reuters
Alicja Siekierska is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @alicjawithaj.