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OTTAWA (Reuters) - Soaring oil prices will push Canada's inflation higher until it peaks at 4.3 percent in early 2009, the Bank of Canada said on Thursday, while this year's second-quarter economic growth is expected to come in at 0.8 percent, stronger than previously thought.
The central bank, in an update to its April Monetary Policy Report, also said it is not poised to raise interest rates, saying the current 3.0 percent overnight rate remains appropriate.
Even though prices overall are expected to spike, core inflation, which strips out volatile items and guides rate decisions, will stay below its 2 percent target throughout this year and next, the bank said.
Despite projecting the highest inflation rate since 2003, the bank emphasized the spike would be temporary and that Canadians are largely confident that inflation will stay contained, citing "a number of indicators of inflation expectations."
After the economy's unexpected contraction in the first quarter of 2008, the bank now sees second-quarter growth coming in stronger than it previously thought due to solid domestic demand. Its current 0.8 percent projection compares with an earlier 0.3 percent projection.
But it sees annual 2008 growth at 1.0 percent, down from a 1.4 percent projection previously. The adjustment reflects the slack first quarter and slower-than-expected growth in the second half of the year as weak U.S. demand holds back Canadian net exports.
Commodity price increases are a net benefit to Canada. They "have led not only to higher global inflation, but also to continued improvements in Canada's terms of trade and increases in real national income," the update said in explaining the economy's stronger-than-expected momentum going into the second half of the year.
The 0.3 percent first-quarter contraction came after the bank's April report saw 1.0 percent growth. On Thursday, the bank said it missed the mark because growth in household spending fell short and a drop in inventory investment -- after a buildup in late 2007 -- was steeper than it had thought in April.
For the second quarter, the bank said growth in domestic demand likely remained solid, though net exports probably were an offsetting factor. But inventory investment was not expected to prove a drag on growth as it was in the first quarter.
"Strong income gains from high commodity prices and high levels of employment, as well as an expected improvement in financial conditions, should support the growth of domestic demand through 2009 and 2010."
Unexpected strength in the U.S. economy in the first part of this year prompted the bank to raise its 2008 U.S. economic growth forecast to 1.6 percent from 1.0 percent.
Even so, the bank cautioned that stubborn weakness in the U.S. economy, turbulence in global financial markets and surging prices for commodities, especially energy, could present risks to its inflation and growth projections.
The value of the Canadian dollar, which the bank still assumes will average 98 U.S. cents, would normally have risen more in line with commodity prices but appears to have been weighed down by concerns about the U.S. economic outlook, the bank said.
Reporting by Louise Egan; Editing by Frank McGurty