Canada Core Inflation Slows, Leading Investors to Pare Bets on Rate Rises

The cost of living in Canada climbed less than forecast in July, prompting investors to pare bets the Bank of Canada will raise interest rates again as early as next month.

The consumer price index rose 1.8 percent in July from a year ago following June’s 1 percent gain, Statistics Canada said today. The rise reflected a new sales tax in two provinces and fell short of forecasts for a 1.9 percent rate, based on the median of 19 estimates in a Bloomberg survey. Underlying inflation as measured by the core rate, which excludes eight volatile items and changes to indirect taxes, unexpectedly decelerated.

Canada’s dollar weakened after the report, which follows data in recent weeks that have shown the recovery may be wavering. The odds of the Bank of Canada raising its interest rate to 1 percent at its Sept. 8 meeting fell to 44 percent from 60 percent on July 19, according to a Credit Suisse Group AG calculation derived from overnight index swaps.

The inflation report and weaker-than-expected growth “certainly gives the bank plenty of license or leeway to take at least a temporary pass in its rate hike campaign,” said Doug Porter, deputy chief economist at BMO Capital Markets in Toronto.

Signs of Weakness

Employment and wholesale sales reports this month have failed to meet economist forecasts, while the country’s trade deficit was higher than expected.

The bank has raised its key rate twice since the start of June to 0.75 percent, even as it’s trimmed its Canada growth forecast. The bank’s policy makers next meet on Sept. 8 to decide on interest rates.

“I’m not convinced they’re going to raise rates” next month, Porter said. “That’s very much an open question.”

The Canadian dollar depreciated 0.7 percent to C$1.0481 per U.S. dollar at 9:41 a.m. in Toronto, compared with C$1.0404 yesterday.

The rate on the three-month overnight index swap fell 2.5 percent to 0.8765 percent. The rate measures what investors predict the central bank’s benchmark will average over that time.

Core Prices

The measure of core inflation, which excludes the tax changes, decelerated to 1.6 percent from 1.7 percent. Economists forecast the core inflation rate would accelerate to 1.8 percent.

The Bank of Canada, which has said it will “look through the transitory effects” of the tax changes on inflation, projected the “harmonized” sales taxes in Ontario and British Columbia that took effect July 1 will raise the inflation rate by 0.6 percentage point from July to June 2011.

Ontario and British Columbia, two of Canada’s three largest provinces, merged their sales tax with the existing federal levy on July 1, making some goods and services taxable for the first time. Nova Scotia also raised its sales tax by 2 percentage points.

Policy makers predict core inflation will average 1.8 percent over the next three quarters, with overall average inflation rising to 2.2 percent.

“The report provides yet further evidence that price pressures remain mild, which should give the Bank of Canada some comfort in ramping down its tightening bias as it contemplates taking a long pause after a September rate hike,” Krishen Rangasamy, an economist with CIBC World Markets, said in a note to investors.

Dollar Declines

Both total and core inflation will advance at about a 2 percent pace through 2012 as the economy returns to full capacity, the central bank predicts. The bank’s forecast anticipates a “gradual” rise in interest rates to keep inflation at that pace.

Consumer prices rose 0.5 percent during the month of July, the fastest increase since November, while falling 0.1 percent on a core basis. Economists surveyed by Bloomberg forecast a 0.6 percent rise in the overall index, and a 0.1 percent gain in the core rate.

Electricity prices led the rise in annual inflation, with a 9.8 percent increase. Homeowner replacement costs, up 5.5 percent, and gasoline’s 4.8 percent gain were also cited by the statistics agency as main contributors to rising inflation.

Falling costs on mortgage interest, women’s clothing and air transportation tempered the gains, Statistics Canada said.

To contact the reporter on this story: Theophilos Argitis in Ottawa at targitis@bloomberg.net.

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