Lower inflation gives BoC rate flexibility

The rise in prices Canadians pay for most goods began to moderate last month, dipping below 3% for the first time since July and beginning what analysts expect is a trend to lower inflation.

Statistics Canada said Friday that annualized inflation fell three-tenths of a point to 2.9% in October, while the core index—which excludes volatile items such as energy and some fresh foods—edged down a notch to 2.1%.

That is slightly higher than economists had predicted, but the downward trend should offer some comfort to the Bank of Canada, which had been resisting interest rates hikes on the premise that inflation would soon come off its May peak of 3.7%.

The so-called headline inflation rate is expected to continue to slide in upcoming months as the significant oil price spike of last fall starts becoming less of a factor on the index.

Earlier in the week, the U.S. reported its inflation rate was also starting to come off its recent peaks.

“We had a big run-up (last year) and now they’ve levelled off,” said David Madani of Capital Economics.

“If you just assume gasoline prices remain at current levels, then the year-to-year change is going to be erased very quickly.”

October’s inflation report offered an indication of the impact on gas prices to the overall index. Canadians are still paying 18.2% more to fill up at the gas station than they did last October, but that is a significant drop-off from the 22.7% annual increase recorded in September.

Analysts are divided as to what bank governor Mark Carney should do with the flexibility that moderating inflation affords him.

Madani believes Carney’s next move is to cut short-term interest rates even further to boost the sagging economy. The bank’s trendsetting overnight rate is already at the super-low level of 1%, helping push interest rates on everything from mortgages to car loans to historic lows.

Others believe the central bank won’t act on interest unless economic conditions either improve or deteriorate dramatically.

“The key message is, we think interest rates will remain unusually low for a very long period of time and today’s inflation report provides more information along those lines,” Madani said.

The Canadian dollar rose on the report and was up 0.29 cents to 97.54 cents US at mid-morning trading, an indication investors trimmed expectations of a rate cut.

Bank of Montreal economist Robert Kavcic said the bank has more important worries than inflation at the moment. It is already expecting the economic output to cool to 1.9% growth next year, an assumption it bases on the expectation, growing more risky each day, that Europe will be able to contain the debt crisis within the continent.

“Suffice it to say that inflation has taken a back seat to the ongoing financial market turmoil and economic uncertainty,” he said.

While inflationary pressures are easing, they have not all been flushed out of the system, Friday’s report showed.

Core inflation, which measures underlying price pressures, only slid to 2.1% when analysts had predicted a bigger drop to 1.9%, as food and car prices proved stickier then expected. Food prices rose 4.3% in October, the same rate of increase as the previous month.

Statistics Canada said excluding the energy and food components, the average annual increase in consumer prices would be 1.5%.

Overall, prices rose on all eight components tracked by the agency, but the pace of increases slowed with most.

The cost of transportation in October rose 6.7%, down from 7.9% the previous month. The pace of inflation also moderated for clothing and footwear, recreation, education and reading, alcohol and tobacco, and household operations.

An anomaly in the report was that consumer goods, when measured on a month-to-month basis, actually increased by a modest 0.2%. That means while prices rose slightly in October from September, the jump was not as large as it was in the corresponding period last year.

Regionally, inflation eased last month in every province of the country except Alberta, where it jumped six tenths of a point to 3.4%.