Canada Faces Two-Decade High Inflation With Carney on Sidelines

The cost of living for Canadians is set to grow at the fastest pace since 1991 this year as concerns about the global recovery keep Bank of Canada Governor Mark Carney from raising borrowing costs.

The annual rate of consumer price inflation has averaged 3 percent over the first 11 months of this year, according to data released today by Statistics Canada. Without a dramatic drop in December, average full-year inflation will surpass the two-decade high of 2.8 percent recorded in 2003 to become the fastest since Canada adopted inflation targets two decades ago.

“I would say without a shadow of a doubt under more normal times we would have had the Bank of Canada tightening in the second half of this year,” Doug Porter, deputy chief economist at Bank of Montreal’s capital markets unit in Toronto, said in a telephone interview. Porter cited the two-decade high record in a research note today.

The Ottawa-based central bank has kept its key policy interest rate unchanged at 1 percent for 15 months, citing Europe’s deepening debt crisis and a weak U.S. recovery, even as energy costs have kept consumer price increases above its 2 percent target. Carney, who has said he has “flexibility” in how soon inflation returns to target, predicts the pace of price gains will slow to 1 percent by the middle of next year.

“The outlook for the Canadian economy has weakened since July,” the Bank said in its October monetary policy report, citing “the significantly less favorable external environment” and projecting economic momentum “to remain modest through the middle of next year.”

Inflation Expectations

Investors have increased bets the bank’s forecast will be accurate. Canada’s 30-year break even rate, a gauge of inflation expectations, has declined to 2.01 percent from 2.26 percent at the end of October.

Higher prices may have added to the economy’s woes by slowing consumer spending, Porter said. Hourly wage growth has averaged 2 percent this year, according to Statistics Canada data, one percentage point less than price increases, meaning real wages have fallen. Personal expenditures grew by 1.9 percent in the third quarter from a year earlier, the slowest pace since 2009.

Much of the pick-up in Canada’s inflation rate has reflected higher global oil prices, food costs and increases in provincial sales taxes, items which are excluded from the bank’s so-called core rate of inflation. While the increase in the core rate has averaged 1.7 percent this year, the same pace as last year, it has been above 2 percent for the past three months.

The two-decade record “does come with a bit of an asterisk because sales taxes played a big role,” Porter said.

Sales Tax Increases

The Bank of Canada estimated last year that sales tax increases in Ontario, British Columbia and Nova Scotia boosted inflation by 0.7 percentage points from July 2010 to June 2011.

The average annual increase for gasoline this year has been 20.1 percent, more than double the pace over 2010, according to Statistics Canada data. Food price increases have averaged 3.7 percent this year, compared with 1.4 percent in 2010.

While the weak global outlook has economists forecasting that Carney won’t raise borrowing costs in 2012, potential inflationary pressures will probably keep him from lowering the benchmark rate, even if the global outlook worsens and other central banks choose to ease policy, said Matthieu Arseneau, an economist at National Bank Financial Inc. in Montreal.

“They will stay on the sidelines for the foreseeable future,” Arseneau said in a telephone interview.

U.S. Inflation

Canadians aren’t alone in coping with cost increases this year. Inflation in the U.S. has averaged 3.2 percent this year, double the 1.6 percent average increase in 2010, and down from 3.8 percent in 2008.

Statistics Canada today said the country’s annual inflation rate was unchanged at 2.9 percent in November, as rising food and automobile prices offset a drop in gasoline prices. On a monthly basis, consumer price increases eased in November, growing at a 0.1 percent pace compared with a 0.2 percent pace in October.

The central bank “can seek a little more comfort in this inflation report,” said Derek Holt, Scotia Capital’s vice president of economics in Toronto, adding the central bank’s outlook for a sharp decline in inflation seems “aggressive”.

“We’re going to need a series of reports like this” before the Bank of Canada’s outlook “comes to fruition,” Holt said.

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