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    Home »  News »  Business

    Receding inflation likely signal low interest rates here to stay: economists

    OTTAWA - Inflationary pressures have all but vanished in Canada amid weak economic conditions, high consumer debt and the strong dollar, giving the Bank of Canada yet another reason to keep interest rates low longer.

    The country's annual inflation rate held at 0.8 per cent for the second consecutive month in December, but an even bigger surprise was that prices dropped 0.6 per cent compared with November, suggesting retailers marked down prices to attract Christmas shoppers.

    The results were much softer than analysts expected, and also weaker than the Bank of Canada anticipated in this week's monetary policy review.

    Economists said the inflation report, and expectations of similar results in the next six months, all but squelches any expectations that the central bank will be raising rates in 2013. Some said a cut to interest rates is now back in play.

    "While the Bank of Canada's recent dovish announcement quashed expectations for a rate hike any time soon, today's inflation report put a nail in the coffin," said economist Emanuella Enenajor of CIBC World Markets, reflecting the consensus.

    That put even greater downward pressure on the Canadian loonie, which saw its relative value fall 0.44 of a cent to 99.14 cents US in early morning trading, its lowest level since late July.

    The loonie has been sliding since Wednesday, when the Bank of Canada shaved projections for economic growth this year and governor Mark Carney declared that the need to raise borrowing costs was "less imminent."

    Low inflation adds to selling pressure on the currency because it removes a compelling rationale for increasing interest rates.

    Analysts interpreted the statement as signal the bank's trendsetting policy rate would remain at one per cent well into 2014.

    The market expectation for inflation had been to bounce back to 1.2 per cent after November's dip, but the results were weaker than anyone expected. The retreat in prices, particularly from November-to-December were pronounced and broad-based.

    Gasoline prices fell 2.4 per cent from November, passenger vehicles cost 1.2 per cent less on average and clothing dropped 4.4 per cent. Hotel rates and mortgage interest costs also fell month-to-month.

    "I think there are few stories going on here," said Bank of Montreal economist Doug Porter. "I do think the persistent strength of the dollar, until recently, is having an impact, slowing but surely chipping away at pricing power. And obviously (Christmas) discounting was even more intense than usual."

    Porter added the impending entry of the Target department store in Canada may have also played a role, with retailers readjusting prices in expectation of future stiff competition.

    David Madani of Capital Economics said the further decline in core prices which omits volatile items such as energy and some fresh foods to 1.1 per cent from 1.2 suggests there is more slack in the economy than previously thought.

    "With sub-par economic growth forecast ahead, disinflationary pressures are only going to get more intense, with underlying inflation possibly falling below the bank's one-to-three per cent target range. This is more evidence that interest rates may be headed lower," he said.

    On Wednesday, Carney said he still believed the next move will be to raise interest rates, but also did not categorically dismiss a cut if the economy continues to underperform.

    For 2012 as a whole, Canada experienced the weakest inflation year since 2009, when the economy was in recession.

    Statistics Canada said price increases last year averaged 1.5 per cent about half the rate of 2011.

    "The slower increase in the CPI (consumer price index) in 2012 ... was largely attributable to smaller price increases in gasoline and food," the agency said.

    Pump prices rose 2.5 per cent last year compared with 20 per cent in 2011, and food price hikes averaged 2.4 per cent, compared with 3.7 per cent in 2011. Analysts had predicted the summer drought in the U.S. would eventually push food prices higher, but the flow through has yet to materialize in North America in any significant way.

    On a year-to-year comparison, mortgage costs, autos, video equipment, fresh vegetables and natural gas all fell in December.

    The main positive contributors to inflation last month were food, which rose 1.5 per cent, and alcohol and tobacco products, which rose 1.8 per cent. Individually, cable and satellite services rose 5.9 per cent, meat prices increased 4.4 per cent and prices for household operations, furnishings and equipment were up 1.3 per cent.

    Porter noted that low inflation, along with low interest rates and the relatively healthy job market is created a bit of a "bonanza" for Canadian consumers. But he said there's a downside to the story as well.

    "Some of this is being driven by a weak consumer backdrop, and the pressure from cross-border shopping, which is not good news," he said.


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