OTTAWA (Reuters) - Inflation in Canada soared in March, stunning markets, and when combined with signs of frothy first-quarter growth raised the likelihood the central bank will soon resume interest rate hikes.
Due to sharp rises in gasoline and food prices, the annual inflation rate shot up to 3.3 percent in March, Statistics Canada said on Tuesday, the highest level since September 2008 and above the Bank of Canada's comfort zone.
On a month-on-month basis, the consumer price index climbed 1.1 percent from February, the sharpest rise since January 1991.
"I was definitely surprised by the numbers. Everyone was surprised. (It was) quite a bit stronger than expected," said Jacqui Douglas, a senior currency strategist at TD Securities in Toronto.
"The markets have been tossing around when exactly the first (Bank of Canada) hike is going to come. It definitely looks like it's going to come in the next couple of months as opposed to later this year," she said.
The Canadian dollar strengthened after the report and markets began pricing in a slightly higher probability of rate hikes at every Bank of Canada policy-announcement date this year. Most still rule out a move on May 31 and see July as the earliest date the bank will tighten credit.
The core inflation rate, closely watched by the central bank, remained tame but it was also higher than markets had expected.
The Bank of Canada targets inflation at the midpoint of a 1 to 3 percent range.
Until March, Canada had largely bucked the trend of rising prices seen in many other countries. The Canadian dollar's recent rise to 3-1/2 year highs has helped to dampen import costs.
Statscan also reported on Tuesday that February wholesale trade gave back some of the gains made over the previous six months, declining 0.6 percent, but activity remained above pre-recession levels.
The composite leading indicator rose 0.8 percent in March, double the increase that had been forecast, on the heels of a revised 1.1 percent gain in February.
Analysts said data so far points to fairly weak growth in February but strong growth in the first quarter overall.
"Our view has been that as we go forward, we are going to see continued persistent strength in the economy and that the bank will be looking to restart its (rate-hike) program in the summer months," said Dawn Desjardins, assistant chief economist at Royal Bank of Canada.
"I don't think this in and of itself will be enough to jump-start things, but at the same time it is certainly something they are going to keep a very keen eye on as it runs a bit contrary to some of the things they've been worried about."
The central bank was the first in the G7 advanced economies to begin raising interest rates last year, but has kept its rate unchanged at 1 percent since September, pending more evidence that the global recovery is gaining strength.
In its quarterly report on April 13, the Bank of Canada projected total CPI would peak at around 3 percent at some point in the second quarter due to the impact of higher energy and food prices as well as provincial changes to sales taxes.
It said it expected the rate to ease back to the 2 percent target by mid-2012.
Core inflation, on the other hand, had fallen in previous months and the bank saw it rising to its target in roughly the same time frame.
The Canadian dollar rose as high as C$0.9552 to the U.S. dollar, or $1.0469, following the data on Tuesday, up from Monday's close of C$0.9642 to the U.S. dollar.
Overnight index swaps, which trade based on expectations for the key central bank rate, showed a 91.2 percent probability the central bank would keep rates unchanged in May, down from over 99 percent on Monday. Markets have fully priced in a quarter-point increase by September.
With additional reporting by Howaida Sorour, Ka Yan Ng, John Tilak and Euan Rocha; editing by Peter Galloway