July 20, 2012 / 12:53 PM / 5 years ago

Canada inflation perks up but rate hike seen distant

OTTAWA (Reuters) - Canadian inflation climbed in June from a two-year low in May, but the weaker-than-expected report looked unlikely to spur the Bank of Canada to act any time soon on its warning that it could raise interest rates.

Annual inflation rose to 1.5 percent last month from 1.2 percent in May, well below the Bank of Canada’s 2 percent target, according to Statistics Canada data on Friday. A drop in gasoline and natural gas prices partially offset higher prices for passenger vehicles and electricity.

Core inflation, which strips out gasoline and seven other volatile items, came in at 2.0 percent from 1.8 percent in May.

Analysts in a Reuters poll had forecast June inflation at 1.8 percent and a core rate of 2.3 percent.

“It looks to be lower than expected pretty much across the board. Not shockingly weak, but definitely well clear of expectations on the low-side on both headline and core,” said Doug Porter, deputy chief economist at BMO Capital Markets.

Bank of Canada Governor Mark Carney has broken ranks with his global peers in signaling plans to raise, rather than ease, interest rates as strong domestic spending keeps the economy growing even as the crucial export sector struggles.

The central bank on Tuesday extended a two-year freeze on its benchmark lending rate, holding it steady at 1.0 percent, but repeated is hawkish statement that rate hikes “may become appropriate” even as it cut growth and inflation forecasts.

Inflation averaged 1.6 percent in the second quarter, a notch below the bank’s prediction, while the average core rate was right on the mark at 2.0 percent.

“It’s a little bit less of a bounce back than expected going into the report, so I think it might suggest less need for the Bank of Canada to tighten; we might see a little downward pressure on rates and the (Canadian) dollar as well,” said Paul Ferley, assistant chief economist with Royal Bank of Canada.

Inflation is expected to soften further in the third quarter as commodity prices continue to drop from year-ago levels, pushing down the cost of retail gasoline.

The Canadian dollar weakened to a session low of C$1.0131, or 98.71 U.S. cents in the wake of the data, down from its close of C$1.0078 against the U.S. dollar, or 99.23 U.S. cents on Thursday. <CAD/>

Overnight index swaps, which trade based on expectations for the central bank’s key policy rate, showed that traders slightly increased bets on a rate cut in late 2012 after the inflation data.

However, most economists expect the Bank of Canada’s next move to be a hike. A recent Reuters poll showed the next policy tightening is expected in the second quarter of 2013. <CA/POLL>

Additional reporting by Claire Sibonney, Julie Gordon and Euan Rocha in Toronto; Editing by Jeffrey Hodgson

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