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Tame inflation tags loonie, gives Bank of Canada comfort

OTTAWA — The Bank of Canada received more reason to keep interest rates at record lows Wednesday amid inflation data that indicates the slack economy will keep prices in check throughout the year.

OTTAWA — The Bank of Canada received more reason to keep interest rates at record lows Wednesday amid inflation data that indicates the slack economy will keep prices in check throughout the year.

Statistics Canada said the annual inflation rate rose to 1.3 per cent in December — three-tenths of a point less than expectations — but even that modest uptick exaggerated underlying inflationary pressure.

The more important number, say economists, is that consumer prices actually slid 0.3 per cent in December compared with November. Meanwhile, core inflation, which excludes the volatile energy component, remained a tame 1.5 per cent and well below the central bank’s target of two per cent.

News of the surprisingly low inflation reading sent the loonie, which had already been weakening on falling commodity prices, down even more.

At one point the loonie was down 1.68 cents at 95.34 cents US, before recovering slightly to finish down 1.51 cents at 95.51 cents US.

“There are two big factors at play,” said Douglas Porter, deputy chief economist with BMO Capital Markets.

“The underlying weakness of the economy means businesses can’t raise prices and the other big factor is the renewed strength of the Canadian dollar, which is quashing import prices.”

The bigger factor for the dollar, added Porter, is that flat inflation prospects going forward relieves central bank governor Mark Carney of any urgency to abandon his near-zero policy rate any time soon.

“The way markets look at it is (that) because inflation remains subdued, it puts even less pressure on the Bank of Canada to raise interest rates and that softens the currency,” Porter said.

Carney, who will hold a news conference after releasing a detailed analysis of the bank’s view on the economy Thursday, has committed to maintaining the policy overnight rate at 0.25 per until after June.

CIBC economist Krishen Rangasamy notes that the muted inflation picture is taking place at a time when the pressure on prices should be building. Those pressures include low interest rates that can lure consumers into spending more than they might otherwise, and a recovering economy.

“(But) excess capacity and the strong currency are allowing Canadians to benefit from low prices and therefore low interest rates for longer,” Rangasamy said.

On Tuesday, the Bank of Canada said the economy was operating at 3.5 per cent below capacity and there was more proof of that slack in factory output Wednesday.

Manufacturing sales rose a meagre 0.1 per cent in November, Statistics Canada reported, while volumes registered an outright decline of 0.8 per cent. Both numbers were well below expectations.

TD Bank economist Francis Fong noted that manufacturers are a long way from recovering to pre-recession levels, pointing out that from July of 2008 to May 2009, sales in the sector plummeted 28 per cent.

Given the excess capacity, some economists now see Carney holding steady on rates until the fourth quarter of this year, which is good news for Canadians looking to negotiate mortgages or take out car loans.

December’s data shows that whatever inflationary pressure exists in Canada, much of it has to do with gasoline prices. The cost of filling up at the pump was 25.6 per cent higher last month than in December 2008, when petroleum prices were tumbling in the face of a global economic slowdown.

Excluding the energy component in the consumer price index, annual inflation would have stood at a tame 0.4 per cent in December.

Despite a wild year for measuring fluctuations in consumer prices — with prices mostly falling in the first nine months and rising in the last three — Statistics Canada noted that 2009 was remarkably stable, with the index moving up modest 0.3 per cent on average from 2008.

Now, with oil prices stabilizing near current levels, the effect of gasoline prices on annual inflation is expected to fade over the next few months, analysts said.

Economists believe both the headline and core inflation rates will average about 1.5 per cent this year.

In December, six of the major components tracked by Statistics Canada recorded price increases, led by the energy-related transportation sector, which rose 4.7 per cent from the previous year.

Food prices were 1.7 per cent higher and household operations rose 1.9 per cent. Health and personal care, recreation, education and reading materials, and alcohol and tobacco also increased moderately.

But prices were 1.7 per cent lower on a year-to-year basis for shelter, as a result of lower heating costs and mortgage interest. Clothing and footwear, and the cost of passenger vehicles, were 3.3 per cent lower than a year ago.

Regionally, Statistics Canada said inflation was highest in the Atlantic provinces and lowest in the West.