June 20, 2008 / 4:02 AM / in 9 years

Bank of Canada vows relentless focus on inflation

CALGARY (Reuters) - Bank of Canada Governor Mark Carney on Thursday sought to justify his surprise decision last week to hold interest rates steady, rather than lowering them, saying an unprecedented rise in commodity prices required a “relentless focus on inflation.”

Carney, speaking in Canada’s oil capital, said the global spike in energy and food prices was unlike any previous commodity boom because the increases have been so steep and have encompassed such a broad range of goods.

Carney described the phenomenon as a “commodity super cycle,” suggesting a period of rising prices that outlasts the usual business cycle of seven or eight years.

“In the face of the largest commodity-price shock in our lifetimes, we cannot be complacent,” Carney said.

At the same time, he warned Canada, as a net exporter of crude oil, to guard against squandering its growing wealth like many economists say the country had done in the 1970s.

Carney reminded his audience of a ubiquitous bumper sticker in Alberta during that time, without repeating the refrain. It read: “Lord, give us another oil boom and we promise not to piss it away again.”

“The question now is how to make good on that promise,” he said in his speech to a conference sponsored by the Haskayne School of Business in Calgary, Alberta.

Against that backdrop, he said, the central bank was forced to abandon its view, clearly stated in April, that more rate cuts were needed to shield the economy from the U.S. slowdown and credit market turmoil.

He told reporters after his speech that inflation could tip higher in coming months. “The trend is there. That importantly assumes that current energy prices remain and ... this is a spike that’s being driven by energy prices,” he said.

Unlike the last boom, the Bank of Canada should not respond by lowering interest rates to prevent an economic contraction, a policy Carney said had led to double-digit inflation in Canada in the early 1980s.

“While commodity-price shocks raise complex issues, a relentless focus on inflation clarifies policy decisions, makes communication easier and maximizes the likelihood that expectations will remain well anchored,” Carney said.

The bank’s decision to hold its overnight rate steady at 3 percent on June 10 stunned markets. To be sure, many market players were not opposed to the bank’s hawkish tone, which echoed that of the U.S. Federal Reserve and the European Central Bank. Rather, they were perplexed because the Canadian bank had uncharacteristically given no prior signal of its plans. That divergence between market expectations and the rate decision was not ideal, Carney said.

Since then, many have wanted to know what data guided the bank in its decision. Carney, who said the bank did not give signals or “code words” on its decisions, spelled it out for them in his speech on Thursday.

Commodity prices rose 10 percent between the bank’s April and June rate decisions, according to the Bank of Canada’s commodity price index, and the futures curve for oil rose sharply. That will boost incomes and, on balance, is a good thing for Canada, he said.

At the same time, the global economy grew faster than expected and global inflation also picked up more speed, raising the risk that Canada will no longer be immune to food price inflation.

On the other hand, the Canadian dollar’s rise to parity with the U.S. dollar appears to have led to lower prices for cars and books, but little else.

Carney also made it clear that he needs to convince Canadians, horrified by the skyrocketing cost of filling their gasoline tank, that he will not allow prices to get out of control permanently.

“People’s expectations for future inflation do influence actual future inflation rates,” he said.

Carney said the bank would not rely on any one measure of inflation, but analyze several different indices.

In the past it has considered core CPI, which excludes volatile items like gasoline, to be the most reliable indicator of underlying inflation.

Earlier Thursday, however, Statistics Canada reported that core annual inflation remained tame at 1.5 percent in May.

But overall consumer prices rose by a sharper-than-expected 1.0 percent in May from April, the single largest monthly rise since January 1991 due to soaring gasoline prices. The annual inflation rate quickened to 2.2 percent from 1.7 percent the previous month.

Writing by Louise Egan; Editing by Frank McGurty

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