Soft Inflation Dynamics Give Bank of Canada Room to Stay Patient, Says TD
Canadian financial markets seemingly "exhaled" a bit last week, "catalyzed" by constructive developments for the inflation backdrop, said TD.One important trigger was messaging that a United States-Iran deal may be in its final stages, noted the bank. Accordingly, oil prices slid.The other major catalyst was an April inflation report that was soft at its core. The Canadian five-year bond yield, which underpins the popular five-year mortgage rate product, was off about 15 bps on Friday while equities were higher on the week.Markets were braced for a "3-handle" on inflation last month. Instead, overall inflation clocked in at 2.8% year over year. While this was an acceleration from March, as expected given the jump in gasoline prices, there was little evidence that the inflationary pressures from the Iran war were materially feeding into prices more broadly yet, stated TD.There are a few caveats to keep in mind with April inflation, pointed out the bank. One is that it takes time for a spike in energy costs to feed through into core inflation. The bank reckons that Canada should be seeing some pass-through starting in June, which is also when hotel rates will be pressured higher by the World Cup games played in Toronto and Vancouver.The second is that soft underlying inflation could be signaling a weak economy that's limiting the ability of firms to pass through cost increases, added TD. Indeed, last week featured a steep 0.7% monthly decline for March retail sales volumes.Looking ahead, this week will bring the Q1 real gross domestic product report and a preliminary monthly reading for April. TD thinks the economy expanded by about 1.5% annualized in Q1, in line with the Bank of Canada's forecast.Potentially more interesting will be the early read on Q2 activity. This will be known with certainty this week, but earlier estimates suggest that the monthly GDP was flat in March. The labor market also cooled last month, while preliminary retail spending data points to a subdued performance after stripping away price gains. If economic activity was indeed modest to begin Q2, this could challenge the BoC's call for a 1.5% annualized gain in real GDP.All told, last week's events added notable weight to the narrative that the BoC can be patient on rates, with no move expected at its next meeting on June 10. TD sees the BoC staying on hold for the remainder of the year, conditional on a relatively speedy resolution to the tensions in the Middle East.