Canada’s headline inflation rate slowed more than expected to a pace of 2.7% in June, according to new figures from Statistics Canada.

That’s down from May’s reading of 2.9% and reverses an unexpected surge in inflation between April and May.  

The Bank of Canada’s preferred measures of core inflation were largely unchanged. CPI-median eased to 2.6% (from 2.7% in May) and CPI-trim was unchanged at an annualized pace of 2.9%.

“While headline inflation got back on track in June, the three-month annualized pace of core inflation has now been rising for three straight months,” wrote James Orlando, senior economist with TD Economics. “This infers that the annual pace of inflation should remain in the upper end of the BoC's 1% to 3% range over the coming months.”

Odds of a July rate cut have increased

Still, Orlando says the latest figures have increased the odds of a back-to-back rate cut following last month’s quarter-point reduction by the Bank of Canada. A second cut by the central bank at its July 24 meeting would lower the overnight target rate to 4.50%, down from its peak of 5.00%.

That would result in an immediate reduction in borrowing costs for existing variable-rate mortgage holders, as well as those with personal and home equity lines of credit (HELOCs). There would be no change to interest rates for fixed-rate mortgage holders.

CIBC economist Katherine Judge says the Bank of Canada can comfortably reduce interest rates next week since its latest business and consumer sentiment surveys confirmed inflation expectations are easing.

And with the Federal Reserve increasingly likely to cut interest rates south of the border, she notes the BoC will have to “worry less” about policy divergence between the central banks.

However, some economists believe the Bank of Canada will adopt a more cautious approach to implementing rate cuts.

“Slower inflation and the soft jobs report in June certainly raise the chances of another 25bp cut by the BoC next week, but we still think a pause is more likely,” wrote Michael Davenport of Oxford Economics.

He notes the central bank has been clear about its intention to ease policy gradually and will “likely want to see more evidence of a sustained slowing in core inflation, weaker economic activity, and building slack in the labour market before cutting rates again,” he added.

Lower gasoline prices drove inflation drop

The deceleration in the CPI was led by a drop in gasoline prices, which were down 3.1% month-over-month. Drops were also seen in clothing prices (-3.1% year-over-year) and automobiles (-0.3%).

“The details of the report are consistent with the backdrop of consumers becoming increasingly cautious with discretionary spending,” noted BMO’s Benjamin Reitzes.

Shelter costs eased slightly to an annualized pace of 6.2%, down from 6.4% in May. That included a slowdown in rent inflation to 8.8% (from 8.9%), while the mortgage interest cost component eased to 22.3% (from 23.3%).

However, he also pointed to some “some challenging aspects,” including a 0.6% monthly rise in food prices, along with year-over-year rises in auto insurance (+8.1%) and home insurance (+9.2%) costs.

Meanwhile, services inflation edged higher 4.8% year-over-year (from 4.6% in May).