July 22, 2011 / 11:31 AM / 6 years ago

Inflation unexpectedly tame in June

4 Min Read

<p>Skyscrapers loom over a flagpole carrying the Canadian flag in the financial district in Toronto, March 11, 2009.Mark Blinch</p>

OTTAWA (Reuters) - Canadian inflation slowed sharply in June from an eight-year high in May, giving credence to the central bank's prediction that price pressures would ease and allow it to hike interest rates at a leisurely pace.

Overall consumer inflation eased to 3.1 percent from 3.7 percent in May, still a notch above the central bank's target range. But the rate is expected to drop further in coming months as the July 2010 introduction of higher sales tax will no longer be included in the calculations, chopping 0.6 points off the rate.

Core inflation, which excludes volatile items like gasoline, unexpectedly fell to 1.3 percent in the 12-month period to June from 1.8 percent in May, Statistics Canada said on Friday.

"It's a cold shower, a little bit, for those who are thinking the Bank of Canada may be raising rates as early as September," said Jimmy Jean, economic strategist at Desjardins Capital Markets.

The Canadian dollar weakened to as low as C$0.9504 to the U.S. dollar, or $1.0522, down from around C$0.9465 to the U.S. dollar, or $1.0565, just prior to the data.

Both measures of the consumer price index dropped to the lowest year-on-year rate since February and were tamer than forecast by any of the 19 analysts in a Reuters poll. The median forecast was for overall inflation of 3.6 percent and a core rate of 1.9 percent.

Lower prices for passenger vehicles were the main reason for the softer reading, along with traveler accommodations and a smaller year-on-year hike in gasoline prices. Food prices continued to climb.

Prices fell 0.7 percent month-on-month in June for total CPI and slid 0.6 percent for core CPI.

The bank held its key overnight target rate unchanged at 1.0 percent on Tuesday but signaled that it would need to hike borrowing costs soon. However, central bank chief Mark Carney also made it clear on Wednesday that he saw no need to "normalize" rates by mid-2012 as many market players had expected.

"Any tendency to pull forward rate forecasts to the fall was premature," said Derek Holt, economist at Scotia Capital.

"The biggest risk here is that the Bank of Canada does not hit its forecast of 2 percent core inflation going forward," he said.

The Bank of Canada this week projected core inflation would reach its 2 percent target in the final quarter of this year, two quarters earlier than previously predicted, and remain roughly at that level through to the end of 2013.

In its quarterly Monetary Policy Report, the bank projected total CPI inflation would peak in the second quarter at an average 3.4 percent rate. It said inflation would average 2.8 percent in the third quarter and continue easing to around 2 percent by mid-2012.

Overnight index swaps, which trade based on expectations for the central bank's policy rate, showed that traders priced in lower odds of rate hikes in October and December after the data. A full 25-basis-point rate hike is not priced in until 2012.

The yield on the two-year Canadian government bond, which is especially sensitive to Bank of Canada interest rate moves, fell to 1.48 percent from 1.545 percent just before the report.

Reporting by Louise Egan and Howaida Sorour; Editing by Chizu Nomiyama

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