Canada’s headline annual inflation rate rose more than expected in July, rising by 3.3%, faster than the 2.8% pace recorded in June.

The reading came in above forecasts, with a consensus of economists expecting a rate of 3%. Statistics Canada said the increase was largely due to base-year effects on gasoline prices. Excluding gasoline, CPI growth was 4.1% compared to 4.0% in June.

The mortgage interest cost index continued to rise, reaching a new record pace of 30.6% and remains the largest contributor to overall inflation. StatCan noted that excluding mortgage interest costs, the inflation rate in July would be just 2.4%.

The Bank of Canada’s preferred measures of core inflation, CPI-trim and CPI-median, were little changed in July. Their annualized growth rates came in at 3.6% (from 3.7% in June) and 3.7% (unchanged), respectively.

“Although headline inflation moving back above to 3% is likely to catch some attention, it is what's going on under the hood that is more concerning for the Bank of Canada,” noted Leslie Preston of TD Economics. “The BoC's median and trim inflation measures continued to make progress in July, but at a glacial pace. Underlying inflation remains a long way from the 2% goal.”

What it means for the Bank of Canada

While inflation was expected to tick up in July, the magnitude of the July reading is expected to be concerning for the Bank of Canada, which has indicated future rate moves will be data-dependent and based on a meeting-by-meeting approach.

“There's no sense sugar coating this one—it is not a good report for the Bank of Canada,” wrote BO’s Douglas Porter. “July's result is already at [the Bank’s] call for all of Q3 (3.3%), and the August reading is almost certainly set to be even higher.”

However, he said the modest slowing in core CPI is a “thin silver lining” for policy makers.

“We still believe that with the recent upswing in the unemployment rate and clear signs of cooler spending that the BoC would prefer to move to the sidelines in September and give prior hikes time to work, but the inflation figures will make it a tougher call,” Porter added.

RBC Economics’ Claire Fan noted that the Bank is “clearly willing” to hike rates further if needed, but added that other indicators, such as output growth and unemployment, are now pointing to a weakening economy.

“We look for a softening economy to ease inflation pressures further going forward, and expect the odds are still tilted towards the Bank of Canada foregoing another increase in the overnight rate in September,” she wrote.

July inflation data will be released on September 19, 2023.