On the Radar: Inflation Climbed to 3.2 Percent Despite Falling Oil and the Dollar Sank to a 14-Month Low. Could the Bank of Canada Hike?

Quick takes:

• Canadian CPI climbed to 3.2% in May from 2.8% in April, with gasoline up 33.2% year-over-year, but even excluding gasoline the index accelerated to 2.2% from 2.0%, signaling inflation is broadening beyond energy.
• The Canadian dollar fell to a 14-month low near 70.5 U.S. cents as the two-year yield gap with the United States widened to 137 basis points, the widest since May 2025, making imports more expensive and feeding back into the next inflation print.
• Oil prices continued to fall, with Brent crude dropping below $74 per barrel and U.S. crude briefly dipping below $70 as ships began transiting the Strait of Hormuz again under a United Nations evacuation scheme.
• Bond markets now price a 15% chance that the Bank of Canada hikes at its July 15 meeting and a zero percent chance of a cut.

Monday’s inflation number looked alarming, but it was telling last month’s story. Statistics Canada reported that headline CPI climbed to 3.2 percent in May from 2.8 percent in April, driven by gasoline prices from a month when the Strait of Hormuz was still closed. Oil prices have since fallen sharply, with Brent crude dropping below $74 per barrel by midweek as the U.S.-Iran peace deal took shape.

Currency markets told the other half of the story. The loonie has been sliding for two weeks, hitting a 14-month low near 70.5 U.S. cents on Monday after the Federal Reserve’s hawkish shift widened the gap between Canadian and U.S. bond yields to its widest point in more than a year. A weaker dollar raises the cost of everything Canada imports, adding another inflation pressure just as the energy shock was supposed to be fading.

Inflation is broadening beyond oil

Gasoline was still the headline driver. Prices at the pump rose 33.2 percent year over year in May, the highest since June 2022, when Russia’s invasion of Ukraine created similar supply uncertainty. The Strait of Hormuz remained closed for all of May, and those elevated fuel costs hit consumers across every province.

But the real concern is what happened underneath. Excluding gasoline, the CPI still rose 2.2 percent in May, up from 2.0 percent in April. Food purchased from stores jumped 4.3 percent, marking the 16th consecutive month it has outpaced headline inflation.

Some of those food prices trace directly to trade policy. Tomato prices rose 45.2 percent in May after Mexico reduced planted acreage in response to U.S. tariffs, compounded by poor weather. Computer equipment and software climbed 3.9 percent, the first year-over-year increase since 2020, driven by the same artificial intelligence data centre demand that the Federal Reserve cited as an inflation risk last week.

The Bank of Canada’s preferred core measures held steady, with trimmed-mean CPI at 2.0 percent and median CPI at 2.1 percent. Shelter costs eased to 1.7 percent, and rent inflation slipped to 3.5 percent, its lowest since January 2022. Still, steady core with an accelerating headline gives Macklem neither the ammunition to cut nor the clarity to sit tight with confidence.

The dollar is making it worse

Currency weakness added another layer of inflation pressure this week. The loonie slid to a 14-month low near 70.5 U.S. cents on Monday as the two-year yield gap with the United States widened to 137 basis points, the most since May 2025. That gap reflects the Federal Reserve’s hawkish shift, which pushed U.S. yields higher while Canadian yields stalled.

A weak dollar matters for inflation because so much of what Canadians buy is priced in U.S. dollars or sourced from abroad. When the loonie falls, the cost of imported food, manufactured goods, and raw materials rises, feeding directly into the next CPI reading. That import channel compounds the energy and food pressures already pushing prices higher.

The currency also creates a trap for the Bank of Canada. Cutting rates would push the dollar lower still, amplifying import inflation at exactly the wrong moment. Holding rates keeps the economy under pressure at a time when GDP growth is barely positive and housing activity has slowed.

Oil is falling but the relief is lagging

Oil prices have been the one bright spot. Brent crude dropped below $74 per barrel by midweek, down from the $83 level that followed the initial U.S.-Iran deal announcement, and U.S. crude briefly dipped below $70. Both moves reflect growing confidence that the Strait of Hormuz will reopen.

The framework agreement has held despite a difficult week. Iran briefly re-closed the Strait during talks in Switzerland, and President Trump threatened renewed military action. However, ships are now transiting under a United Nations evacuation scheme, averaging about 25 vessels per day, up from roughly 10 before but still well below the pre-war pace of 125.

Timing is the problem. Monday’s 3.2 percent reading reflects May, when the Strait was still fully closed and gasoline was at its highest since 2022. If oil stays near current levels, relief should appear in the June and July data, but those numbers will not land until August and September, too late for the July 15 decision.

What this means for Canadian mortgage rates

Variable rates are stuck, and the risk has tilted to the upside. The Bank of Canada’s overnight rate flows directly through prime to variable mortgage rates, and with headline CPI at 3.2 percent, Macklem has no room to cut. Bond markets now price a 15 percent chance of a hike on July 15, with zero percent odds of a cut.

Fixed rates remain under pressure from the U.S. side. Canadian lenders price fixed mortgages off Government of Canada bond yields, and those yields take their cue from U.S. Treasuries. With the Federal Reserve signaling hikes and the two-year yield gap at its widest in over a year, the floor under Canadian fixed rates is not coming down.

The weak dollar makes the picture worse for both. If the BoC were to cut, the loonie would fall further, import costs would rise, and the next CPI print would be even higher. That feedback loop is why markets have shifted from debating when the BoC cuts to asking whether it might hike.

What could change the picture

Oil remains the most important variable. If the peace deal holds and Hormuz fully reopens, Brent could fall further toward $70, pulling gasoline prices down enough to bring headline CPI back inside the Bank of Canada’s comfort zone by fall. That would give Macklem room to ease later in the year, even if July is too soon.

If the deal collapses, however, oil prices would spike back, the 3.2 percent reading would look like a floor rather than a peak, and the 15 percent hike probability would rise sharply. The nuclear inspections dispute between the United States and Iran remains unresolved, and Tehran insists it will not give up the right to enrich uranium. That leaves the ceasefire resting on a 60-day roadmap that could fall apart at any point.

On the currency side, a shift in the Federal Reserve’s tone could narrow the yield gap and strengthen the loonie. But the Fed just signaled hikes, and its next meeting is not until late July, so relief on that front is weeks away at best.

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