March 19, 2010 / 3:02 PM / in 8 years

Comeback rolls on as price pressures emerge

OTTAWA (Reuters) - Canadian core inflation stayed unexpectedly high in February and retailers posted solid sales gains in January, according to reports on Friday that helped push the Canadian dollar closer to parity with the greenback.

The data shows the economy is heating up, putting pressure on the Bank of Canada to raise interest rates from record lows although markets still expect the bank to follow through on its pledge to sit on the sidelines on rates until July.

“The numbers were much stronger than expected across the board,” said George Davis, chief technical strategist at RBC Capital Markets, referring to the inflation data.

“That’s going to create a lot of chatter among people in the market in terms of what the bank will be assessing going forward,” he said.

Core inflation, which excludes volatile items such as gasoline, was 2.1 percent year-on-year in February, up from 2.0 percent in January, pressured by vehicle prices as rebates were lifted and a one-time increase in hotel rates due to the Vancouver Winter Olympics.

It was the first time the core rate broke through the 2 percent mark since December 2008. Core CPI jumped 0.7 percent from January.

Markets had predicted the core rate would ease to 1.7 percent year-on-year and rise 0.3 percent from January.

Retail sales beat expectations to increase 0.7 percent in January as Canadians bought home renovations supplies to take advantage of a temporary tax credit in its last month of existence.

Despite transitory effects in the two reports resulting from the Olympics and the tax break deadline, analysts noted signs of sustainable inflationary strength in other details.

“The odds are growing for more aggressive (Bank of Canada) policy tightening in the second half of this year,” said Sal Guatieri, senior economist at BMO Capital Markets.

“It’s not just a one-month aberration. The core measure has consistently surprised on the upside in the past six months, which suggests that the high Canadian dollar is not dampening prices as much as we would anticipate,” he said.

BOC MAY TURN MORE HAWKISH

The Bank of Canada targets 2 percent overall inflation but it closely watches core CPI, which it considers a more accurate gauge of underlying price pressures.

Overall consumer price hikes were closer to forecasts, climbing 0.4 percent in the month as expected and 1.6 percent in the 12-month period, versus a 1.5 percent estimate.

Canada’s dollar, which has risen about 7 percent since early February, hit a session high of 99.38 U.S. cents after the retail sales data, its strongest level since July, 2008.

The currency has been trading near 20-month highs, partly on expectations the Canadian central bank will hike rates before its U.S. counterpart, the Federal Reserve, does.

The Bank of Canada may turn even more hawkish after the inflation data, said Camilla Sutton, currency strategist at Scotia Capital.

Yields on overnight index swaps, which trade based on expectations for the Bank of Canada’s key policy rate, edged higher after the data, showing the markets saw credit tightening as more likely than before. Markets suggest the central bank will hike rates by 25 basis points in July..

The January retail sales also played into the view that the economy is rebounding quickly, but to a lesser extent than the inflation data. Sales jumped 0.7 percent in January for a 6 percent year-on-year increase, but sales volumes disappointed, edging up only 0.1 percent, with much of the sales increase due to price increases.

“This (retail) sector is likely to add only minimally to Canadian economic activity in January, which we expected to grow by around 0.4 percent month-on-month. The higher retail prices confirm the relatively elevated inflation numbers previously reported for January,” said Millan Mulraine, economics strategist at TD Securities.

Sales at building and outdoor supplies stores jumped 7.4 percent, the steepest increase in six years, and sales ex-autos were broadly stronger, gaining 1.8 percent in the month.

Auto sales fell 1.5 percent despite a sharp increase in new car prices.

Additional reporting by Howaida Sorour, Jennifer Kwan and Euan Rocha; editing by Peter Galloway

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