What tamer inflation means for interest rates

David Ljunggren, Reuters
Reuters
The Bank of Canada, which targets a 2.0% inflation rate, this week made it clear it might have to start raising rates from near-historical lows because of reduced slack in the economy and increased underlying inflationary pressures.
OTTAWA — A drop in Canada’s year-on-year inflation rate to an 18-month low in March will not delay interest rate hikes by the Bank of Canada, which is paying closer attention to economic growth, analysts said on Friday.
Statistics Canada said the annual inflation rate fell to 1.9% in March from 2.6% in February, the lowest level since the 1.9% recorded in September 2010. Analysts had forecast a rate of 2.0%.
The Bank of Canada, which targets a 2.0% inflation rate, this week made it clear it might have to start raising rates from near-historical lows because of reduced slack in the economy and increased underlying inflationary pressures.
The central bank has kept rates unchanged since September 2010.
“We now see the bank firmly in a data dependent mode as it considers when and how much of the considerable monetary stimulus currently in place will need to be withdrawn,” said TD Securities strategist David Tulk. “There is nothing in this report in our view that will influence the outlook for monetary policy.”
A Reuters survey of primary market dealers this week showed the median forecast for the timing of the next rate increase had moved to the first quarter of 2013 from the third quarter of 2013.

Statscan said the cost of energy was up 5.1% in the 12 months to March, versus a 7.2% year-over-year rise in February. Food prices were up by 2.2% in the year to March, lower than the 4.1% comparable jump in February.
The closely watched annual core inflation rate dropped to 1.9% in March from 2.3% in February. The core measure strips out prices of volatile items such as fuel and some foodstuff.
“With the economy running closer to full capacity, downward pressure on inflation is likely to be limited,” said Dawn Desjardins, assistant chief economist at RBC Economics.
The Canadian dollar CADD4 lost some early gains against the U.S. dollar shortly after the data was released but by 9.45 am (1345 GMT) had recovered to C$0.9913, or $1.0048, its pre-release level.
The central bank now predicts overall inflation of 2.0% in the second quarter of 2012, rising to 2.2% in both the third and fourth quarters. It has also increased growth forecasts for the first three quarters of this year.
“This report won’t alter the Bank of Canada’s recent more hawkish tone. With the output gap gradually closing and core inflation running around 2%, some withdrawal of the considerable monetary stimulus is certainly looking appropriate,” said BMO Capital Markets economist Robert Kavcic.
Separately, Statistics Canada said the leading indicator rose for the ninth month in a row in March, climbing by 0.4% from February on widespread economic strength.
The increase was slightly less than the 0.5% predicted by market operators. Eight of the indicator’s 10 components advanced in March.