In July, Canada experienced a surge in its annual inflation rate, reaching 3.3 percent, prompting economists to express concerns about the implications for the Bank of Canada. The recent consumer price index report has raised alarms due to its potential negative impact.

This increase in price growth follows a drop in inflation to 2.8 percent in June, marking the first time since March 2021 that it fell within the Bank of Canada's desired range of one to three percent.

BMO's chief economist, Douglas Porter, didn't mince words, stating, "There's no use downplaying this - it's not a favorable report for the Bank of Canada," in a note to clients.

The upswing in inflation last month is attributed to a milder year-over-year decrease in gasoline prices compared to June, as indicated by Statistics Canada.

While a surge in energy prices driven by the Russian-Ukraine situation initially fueled inflation, the subsequent drop in gasoline costs has been a key driver in reducing inflation over the past year.

To see further declines in inflation, other underlying price pressures need to ease. Porter highlights that gasoline prices are anticipated to rise by five percent in August.

Despite signs of economic softening, such as rising unemployment, the latest report has heightened the probability of a rate hike in the coming month, according to analysts.

RBC economist Claire Fan characterized the report as falling short in terms of progress against high inflation.

Porter, though still predicting the Bank of Canada will maintain its current stance, acknowledges that "the inflation numbers will make it a more challenging decision."

As the central bank gears up for its upcoming interest rate decision on September 6, its focus will be on core inflation measures.

RSM Canada economist Tu Nguyen underscores the significance of these figures in gauging the pace of price increases across the economy while excluding more volatile elements.

Nguyen asserts that although the reduction is gradual, core inflation measures are moving in the right direction. This improvement, along with signs of a weaker economy, is expected to lead the Bank of Canada to keep its key interest rate unchanged.

Over the past three months, Canada's unemployment rate has been on an upward trajectory, reaching 5.5 percent.

Nguyen points out that while the inflation numbers might be disconcerting, they aren't entirely unexpected, and the central bank anticipates some fluctuations before reaching the two percent target again.

Last month, the Bank of Canada unveiled new projections indicating that inflation is likely to hover around three percent in the coming year before gradually decreasing to two percent by mid-2025.

This extended timeline for reaching the inflation target prompted the central bank to raise interest rates once more in July, bringing the key rate to 5.0 percent.

Governor Tiff Macklem emphasized that future rate decisions will hinge on incoming economic data. Macklem clarified the bank's intention to see inflation move closer to two percent before concluding the rate-hike cycle.

In the meantime, Canadians are still grappling with soaring grocery prices, although the pace of increase eased slightly. July's grocery prices were up 8.5 percent compared to a year ago, a deceleration from June's 9.1 percent.

This slowdown is mainly attributed to smaller price hikes for fruit and bakery goods. Similarly, travel-related service costs showed signs of deceleration or decline compared to the previous year. For instance, airfare was down 12.7 percent since July 2022.

The rapid climb in interest rates has translated into higher mortgage interest expenses, which Statistics Canada identifies as a major contributor to inflation. Mortgage interest costs experienced another significant year-over-year increase in July, surging by 30.6 percent.

The central bank's hope is that households, confronted with elevated shelter costs due to rising interest rates, will cut back spending in other areas, thereby exerting downward pressure on inflation.

This report from The Canadian Press was initially published on August 15, 2023.