Canada’s Industrial Product Price Index rose 1.2% month on month in May, missing the 1.8% market expectation. The weaker print points to slower month-to-month price gains for goods produced by Canadian manufacturers during the period.
On the available figures, the outturn undershot forecasts by 0.6 percentage points. The May increase still leaves the index higher on the month, but at a more moderate pace than anticipated, adding a softer input to assessments of near-term pipeline inflation pressures in Canada.
Easing Inflationary Pressures And Central Bank Policy
We view the lower-than-expected producer price figure as a clear sign that inflationary pressures are easing more quickly than anticipated. This report, showing a 1.2% increase instead of the forecasted 1.8%, reinforces the disinflationary trend. This gives the Bank of Canada more justification for its recent policy easing.
This data supports the Bank of Canada’s decision to cut its key interest rate to 4.25% earlier this month, a move that made it a leader in easing among G7 nations. With the latest CPI data also showing a cool-down to 2.7%, the market is now pricing in a higher probability of a second rate cut at the Bank’s July meeting. We see this as a solidifying trend, not a one-off event.
Market Implications: Currency, Bonds, And Equities
Consequently, we anticipate further weakness for the Canadian dollar against the greenback, as the US Federal Reserve is expected to hold its rates steady for longer. The widening interest rate differential between the two countries makes holding US dollars more attractive. We are looking to express this view by buying USD/CAD call options expiring in August.
In the rates market, this weaker inflation data suggests that Canadian government bond yields at the front end of the curve have more room to fall. We are considering increasing our exposure to futures contracts on two-year government of Canada bonds. Historically, the two-year yield is highly sensitive to shifts in the Bank of Canada’s overnight rate expectations.
For equity markets, a more dovish central bank is a positive catalyst for the S&P/TSX Composite Index. We see particular opportunity in rate-sensitive sectors like utilities and real estate investment trusts (REITs). We will be exploring buying call options on ETFs that track these sectors, as their dividend yields become more attractive in a lower-rate environment.
