Surgin Inflation Could Push Central Bank To Raise Rates.

Posted on June 29/2011 by

OTTAWA”Canada™s annual inflation rate jumped to the highest level in eight years last month, rising to 3.7 per cent as big increases in gasoline prices pushed the index to a new post-recession peak.

On a month-to-month basis, consumer prices rose by a significant 0.7 per cent in May from where they were in April, Statistics Canada reported Wednesday.

The surprisingly strong results present Bank of Canada governors with a dilemma less than three weeks before their meeting to set short-term interest rates for the country. And market reaction suggested the chances of a rate hike had increased somewhat following the Statistics Canada report.

The Canadian dollar rose more than a penny against the U.S. greenback to 102.82 cents US in pre-market trading.

But analysts were still not convinced bank governor Mark Carney will be spooked enough to risk further depressing a weak economy by raising the cost of borrowing. For one thing, Carney had warned as far back as April he expected inflation to push above three per cent during the spring, although he likely hadn™t envisioned a 3.7 per cent rise.

For another, most of the increase is attributed to one cause petroleum-based energy prices.

Statistics Canada noted that gasoline prices were 29.5 per cent higher in May than they were a year earlier, the largest increase since September 2005 in the aftermath of hurricane Katrina. As well, on top of the 26.4 per cent hike in pump prices that occurred in April, gasoline hit just below the record high reached in July 2008 just prior to the economic meltdown.

Excluding gasoline, the annual inflation rate would be 2.4 per cent, still above where the bank would like it but less threatening.

What will give the central bank some comfort is that core inflation which excludes volatile items like energy and some kinds of food rose only moderately to 1.8 per cent and remains below the desired two-per-cent target. As well, gasoline prices are known to have fallen somewhat in June.

TD Bank deputy chief economist Derek Burleton said indications are that inflation has hit the high-water mark and will soon start heading lower.

All said, look for headline CPI inflation to fall back to below three per cent during the second half of 2011 and for core price inflation to stay below the Bank of Canada™s inflation target of two per cent, he said.

The central banks next scheduled meeting on interest rates is July 19, and analysts said it is unlikely to move the policy rate north of the current one per cent. The bank may want to, but the economy is still too weak, they said.

In normal times, today™s report and the recent trend would strongly argue for hikes coming as early as the next meeting but with the Bank of Canada™s wobbly attitude as of late, this prospect is highly uncertain, said Jimmy Jean, an economic strategist for Desjardins Capital Markets.

CIBC analysts added price pressures could force central bank governor Mark Carney to move before the year is out, however.

May™s data showed price pressures across the board. As well as energy, the cost of transportation also rose strongly in May by 9.1 per cent, largely due to the cost of gasoline.

Another concern is that food prices continued to increase, 3.9 per cent overall, and 4.2 per cent on food purchased at stores. Individual items registered even bigger gains meat cost 5.4 per cent more than a year ago, bread 10.6 per cent, and fresh milk rose 4.3 per cent.

Overall, prices increased at a faster rate in May than the previous month in all major components except shelter. Consumers paid five per cent more for car insurance, clothing rose 1.1 per cent, and prices for recreation, education and reading went up by 2.4 per cent.

Shelter costs, however, were only 1.8 per cent higher in May, compared to the 2.3 per cent increase in April.

Regionally, the inflation rate was higher in eight of the 10 provinces, with Nova Scotia recording the greatest annual increase at 4.6 per cent. All 10 provinces have inflation above three per cent.


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