TD Economics

July 23, 2010

Data Release: Canadian Consumer inflationary pressures ease in June

• Today’s Canadian inflation report provided no major surprises. As widely expected, annual headline
prices decelerated to 1.0% in June, from 1.4% in May. Core inflation edged down to 1.7%, from 1.8% in
the prior month – this is weaker than the 1.9% markets were expecting and marks the third consecutive
month in which core inflationary pressures have eased.

• The largest deceleration in prices came from gasoline and clothing and footwear, and durable goods
which fell 2.9% and 1.8%, and -0.5% from year-ago levels respectively. This was the first annual decline
for gasoline prices since October 2009 but clothing and footwear prices have been on a downward trend
for the last 6 months. A strong Canadian dollar over the last half of 2009 and first half of 2010 likely
weighed on prices for clothing and footwear and durable goods.

• Transportation costs finally began to ease after 5 months of rapid growth. In particular, the annual pace
of growth in the cost to purchase or lease a vehicle slowed to 2.9% in June from 5.1% in the month
before.

• Outside of these components there was a slight broad-based acceleration in service prices. Shelter
costs accelerated for a third consecutive month to 1.7%, up from 1.3% in the prior month – save for the
5% decline in mortgage interest costs due to the drop in home prices and interest rates in early 2009.
Meanwhile communications held its strong pace of 4.8%, led by telephone and postal services. This
component has been a major source of inflationary pressures since November 2009.
Key Implications
• Concerns over the sustainability of the global economic recovery have put a damper on commodity
prices over the last few months, and resulted in a downgrade in our commodity price outlook. The result
will be slower growth in headline inflation in the coming months. Despite base year effects due to the
deflation that took place in June of 2009-September 2009, headline inflation should remain below 2.0%.

• After remaining amazingly resilient through the economic downturn, it now appears that core inflation is
beginning to moderate. Perhaps this is a bit of a delayed reaction to the amount of excess capacity
accumulated over the economic downturn. History does suggest it can take over a year for excess
capacity to weigh on consumer prices.

• Two factors will continue to weigh on prices in the second half of 2010. First, the near-parity levels of
the Canadian dollar during January 2010-April 2010 will keep price growth of imported goods low – it
takes roughly 6 months for Canadian dollar variations to feed through to consumer prices. Second,
wage growth is at a seven-year low, which should temper overall inflationary pressures for the next 6-12
months.

• As an offsetting inflationary pressure, while retailers appear to still be offering discounts to attract
buyers, the amount of excess capacity in the Canadian economy is being eaten up at a swift pace, and
the output gap is now -1.5%, a significant improvement from the -3.5% at the depths of the recession.
Even as economic growth moderates in the second half of this year, the excess capacity will continue to
be mopped up at a gradual pace. Moreover, the Bank of Canada’s outlook survey showed that inflation
expectations remain well anchored at 2%.
 • All said, core inflation is expected to hover in the range of 1.7-1.9% for the rest of this year and next.
With the rate of inflation near the Bank of Canada’s 2.0% target, the Bank can continue to unwind its
monetary stimulus bringing the overnight rate to 1.25% by year end.
Diana Petramala, Economist
416-982-6420

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