Canadian inflation slowed to its weakest pace in two years and core measures edged lower, reducing pressure on the central bank for another interest-rate hike next month.

The consumer price index rose 3.4% in May from a year ago, the smallest increase since June 2021, Statistics Canada reported Tuesday in Ottawa. That matched the median estimate in a Bloomberg survey of economists and was down a full percentage point from 4.4% in April. On a monthly basis, the index rose 0.4%, also matching expectations.

Two key yearly measures tracked closely by the Bank of Canada — the so-called trim and median core rates — also dropped sharply, averaging 3.85% from an upwardly revised 4.25% a month earlier, slightly slower than the 3.95% expected by economists. Service inflation slowed to 4.6%, from 4.8% a month earlier.

A three-month moving average of the measures that policymakers have flagged as key to their thinking fell to an annualized pace of 3.72%, from 3.83% previously, according to Bloomberg calculations.

Bonds got a lift on the news, with the yield on benchmark 2-year Canadian government notes falling around 4 basis points to 4.576% at 9.02 a.m. in Toronto. The loonie was little changed.

The deceleration of both headline and core inflation will likely give Governor Tiff Macklem and his officials some room to hold interest rates steady at their next decision on July 12, if output and jobs figures show signs of a slowing economy. A string of hotter-than-expected data since the central bank declared a pause in January forced it to hike the policy rate earlier this month to 4.75%, the highest since 2001.

“Some signs of tamer core price pressures could provide a bit of breathing space for the Bank of Canada as it decides if, or when, to raise interest rates again,” Andrew Grantham, an economist at Canadian Imperial Bank of Commerce, said in a report to investors.

Before the release of the May inflation data, only eight out of 33 economists in a Bloomberg survey expected the Bank of Canada to raise rates to 5% at its next meeting. Tuesday’s consumer price figures, along with gross domestic product and employment data over the next two weeks, will be key input for policymakers.

Still, sticky underlying price pressures could prompt Macklem and his officials to hike again to squeeze out excess demand in the economy. During their last meeting, they were concerned that monetary policy wasn’t sufficiently restrictive and that inflation could remain stuck above the 2% target.

The large deceleration in May was driven by lower year-over-year prices for gasoline resulting from a base-year effect. Gasoline prices fell 18.3% that month, from a year ago.

Energy prices fell 12.4% in May compared with the same month a year earlier, when supply uncertainty following Russia’s invasion of Ukraine led to surging prices. The first year-over-year decline in natural gas prices since August 2020 also contributed to the deceleration.

The mortgage interest cost index, which rose 29.9% in May, remained the largest contributor to the year-over-year increase. For the third straight month, this was the largest increase on record, as Canadians continued to renew and initiate mortgages at higher interest rates.

Grocery prices remain elevated, rising 9% and nearly unchanged from the 9.1% increase in April. Prices for restaurant food accelerated, increasing 6.8% from 6.4% in April, amid elevated labor shortages and input costs and expenses.

Regionally, prices rose at a slower pace in May compared with April in all provinces, with price growth slowing more in Atlantic provinces due to lower prices for fuel oil commonly used in the region.

--With assistance from Erik Hertzberg and Esteban Duarte.

(Updates with market and economist reaction.)

Author: Randy Thanthong-Knight