The Consumer Price Index dropped to just 1% in May due to lower energy prices. This is the slowest advance since December 2001, and a big drop from 1.7% in April 2002.

However, with persistent core inflation the Bank of Canada isn’t likely to soften its position. The core rate remains at 2.2%, above the central bank’s target level.

TD Bank says that, “All may still appear calm on Canada’s inflation front, but there was not enough soothing news in this morning’s consumer price report to allow the Bank of Canada to sit back and take a breather.” While the headline drop was nice, it notes that core inflation remains stuck at 2.2%, above the mid-point of the Bank’s 1% to 3% operating band.

BMO Nesbitt Burns notes that the Bank has been looking for the core rate to drift below 1.5% in the second half of 2002. “However, it now looks like core inflation will hold close to the Bank’s 2% target through the rest of the year,” it says. CIBC World Markets says that it still expects to see the core rate recede later this year.

“While Canada’s inflation picture is still benign, the fact that the downward pressure on core inflation that the Bank of Canada was expecting in its most recent Monetary Policy Report in April is not materializing, provides the Bank with one more reason to up the ante on the interest-rate front as the year unfolds,” says TD. “In sum, today’s CPI report merely reinforces our view that the Bank will add another 125 basis points to its overnight target rate in the second half of 2002.” BMO agrees that the report will not alter the Bank’s view of the economic world.

“Coming on the heels of hawkish comments from Governor Dodge, the resiliency of core inflation will not go unnoticed. Still, the prospect of a Fed on hold could help convince the Bank that now is not the time to abandon its incremental approach to tightening, keeping it on track for a quarter-point hike in July,” says CIBC. It notes that upcoming employment data will likely weigh more heavily on the Bank’s rate decision.