OTTAWA (Reuters) - Inflation in Canada slowed sharply in June from an eight-year high in May, giving credence to the central bank’s forecast that price pressures would ease and allow it to raise interest rates at a leisurely pace.
Figures released on Friday also showed Canadians spent more than expected in May, boosting retail sales by 0.1 percent. High gasoline prices contributed to the rise but so did warm weather, which encouraged sales of gardening and home hardware supplies, and other general merchandise.
Overall consumer inflation slid to 3.1 percent in June from 3.7 percent in May, Statistics Canada said. Even more surprising was the core inflation reading of 1.3 percent in June, down from 1.8 percent in May. Core inflation strips out volatile gasoline and some food prices.
The Canadian dollar slid after the news and swap markets began pricing in lower expectations of interest rate increases this year.
“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.
Both measures of the consumer price index dropped to the lowest year-on-year rate since February and were lower than forecast by any of the 19 analysts surveyed in a Reuters poll.
Overall CPI inflation was still a notch above the central bank’s target range but it is expected to drop further in coming months as the July 2010 introduction of higher sales taxes in some provinces will no longer be included in the calculations, chopping 0.6 points off the rate.
The dissipating price pressures add a new twist to the ever-changing outlook for Bank of Canada rate hikes. Market players have been forced to revise forecasts repeatedly in face of often contradictory data and signals from the central bank itself.
The bank held its overnight target rate unchanged at 1.0 percent on Tuesday but used more hawkish language to signal it would raise borrowing costs soon. However, Governor Mark Carney made it clear on Wednesday that rates may take longer than usual to normalize from current ultra-low levels due to global economic uncertainty.
The inflation report supports that notion.
“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.
Five of 10 primary securities dealers surveyed by Reuters on Thursday predicted a September rate hike. Two expected the bank would make is first move since last year in October.
The bank 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 overall 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.
Statscan said lower auto prices were the main reason for the softer reading in June, along with cheaper hotel rates 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 overall CPI, and slid 0.6 percent for core CPI.
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 before the CPI data. It briefly pared losses after the retail report. Rate-sensitive government bond yields fell.
Overnight index swaps, which trade based on expectations for the central bank’s policy rate, showed that traders are now betting less that there will be a rate hike at any of the three remaining Bank of Canada policy announcement dates this year. They are not pricing in a full 25-basis-point rate hike until 2012.
The Statscan retail sales report showed an increase in seven of the 11 retail sectors tracked. Dealers of autos and auto parts saw the biggest decline, led by new car dealers.
In the 12 months to May, sales climbed 4.0 percent, compared with a 3.6 percent rise in April.
Additional reporting by Ka Yan Ng, John Tilak and Howaida Sorour; editing by Peter Galloway and Rob Wilson