Canadian Inflation Picks up: Will it Delay BoC Rate Cuts?

Members of the Bank of Canada Governing Council who considered waiting until July to cut rates would not have been reassured by May's inflation data: consumer price gains unexpectedly accelerated to 2.9% year-over-year from 2.7% in April, led by a 4.6% increase in services prices, up from 4.2%.When excluding volatile components - food and energy - the picture is the same: the core index was up 2.9% after 2.7% the previous month.Again, housing-related prices were the main drivers of inflation, led by a 23.3% gain in mortgage interest cost from a year ago, followed by an 8.9% increase in rents. Overall, shelter prices were up 6.4% year-over-year.

So should the BoC worry? The central will undoubtedly remain vigilant: the average of the BoC's own three core measures of inflation remained steady at 2.7% but two readings were up.

That being said, the BoC's April Monetary Policy Report (MPR) projected an average 12-month inflation rate of 2.9% in the second quarter. With May at 2.9% and April at 2.7%, it would take the CPI to reach 3.1% in to top the central bank's projection.

Besides, Governor Tiff Macklem acknowledged that "new bumps" can't be ruled out on the way to the 2% target that he still believes we're on track to reach.

Also bear in mind that the central bank evaluates short-term inflation data within an operating range of 1% to 3%, which means the CPI can deviate from 2%. The trend is the key.

At the beginning of June, the BoC indicated it had room to diverge from the Fed, underlining that inflation drivers have become more domestic than they were when central banks tightened their policy rates globally. Did May's inflation report just shrink that room?

The answer will very much depend on other factors the BoC is looking at:

· Supply and demand in the Canadian economy

· Inflation expectations

· Wage growth

· Corporate pricing behavior.

One aspect will be particularly important in assessing all of these indicators: productivity. Tiff Macklem stressed the day before the May CPI was released that productivity was Canada's weak spot.

In that regard, the central bank's Business Outlook Survey will provide important insight. So be on the lookout on July 15. This report, combined with the Canadian Survey of Consumer Expectations, will likely carry important weight for the July 24 interest rate decision and the pace of policy easing going forward.

With uncertainty about the pace and scope of rate cuts in Canada, how can you position your portfolio?

One positive aspect of higher-for-longer interest rates is that as long as rates remain around current levels, in the US or Canada, investors looking for income can benefit from attractive coupons. For now, interest rate cuts are still on the table, as the BoC said in its June announcement that overall, "policy no longer needs to be as restrictive." Besides, following Canada's May inflation report, the market now still predicts further cuts this year.

This means that there could be potential to benefit from capital gains on the fixed income side.