Canada seen starting brief deflation spell in June

By Louise Egan

OTTAWA (Reuters) - Canadian consumer prices likely fell in the year to June for the first time since 1994, but any deflationary period will be short-lived, analysts said on Wednesday.

Analysts surveyed by Reuters forecast a 0.3 percent rise in the consumer price index -- which reflects the cost of living -- in June from May. But compared with June of 2008, the index is expected to fall 0.3 percent.

The last time that happened was in November 1994 when CPI dropped 0.1 percent. A more substantial decline was last seen in 1953 with a decline of 2.1 percent.

Markets may pay little attention to the news though, because the trend was already telegraphed by the Bank of Canada earlier this year and a prolonged bout of deflation is not expected.

The central bank predicts a period of falling prices that it says will be contained to the second and third quarters. It appears comfortable holding its key interest rate at a floor of 0.25 percent at its next decision date on Tuesday. In April, it pledged to freeze rates through June 2010, conditional on inflation remaining stable.

Analysts surveyed by Reuters see prices remaining flat in the second quarter and falling slightly in the third.

The main reason prices appear lower is because gasoline prices are nowhere near as high as they were in the summer of 2008 when they spiraled to new heights.

When gasoline and other volatile items are stripped out, underlying inflation is expected to be very near the central bank's 2 percent target. The so-called core inflation is forecast at 1.9 percent in June year-on-year and flat on the month.

There is no reason to fear a prolonged bout of deflation nor a sudden spike in prices, economists said.

"Outside of the entire energy picture, particularly with food prices also coming off the boil, it's pretty clear we have a very benign situation as it pertains to inflation in Canada," said Stewart Hall, markets strategist at HSBC Canada.

"The whole story that surrounds the CPI release this Friday is largely undercut by the Bank of Canada already forecasting a short term spate of deflation," he said.

Canada has not experienced a prolonged deflationary period since the 1930s.

Derek Holt, economist at Scotia Capital, rules out a return to those days.

"The month to month changes in CPI are already suggesting an end to the deflation debate," he said.

Senior business managers surveyed by the Bank of Canada in the second quarter also saw inflation getting back on track. Only 11 percent saw inflation falling below 1 percent over the next two years, compared with 41 percent in the first quarter.

Eight out of ten expected CPI to stay within the Bank of Canada's comfort zone of 1 percent to 3 percent.

(Reporting by Louise Egan; Editing by Jeffrey Hodgson)