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Inflation Rises to 2.2 Per Cent in December; Higher Interest Rates Expected

Posted on: Wednesday, 18 January 2006, 15:00 CST

By SANDRA CORDON

OTTAWA (CP) - Higher gasoline prices helped bump up the annual inflation rate to 2.2 per cent in December, which is likely enough to convince the Bank of Canada to keep raising interest rates in the short term, analysts said Wednesday.

The cost of living was still well within the central bank's target range yet it's expected to nudge up borrowing costs - starting with its next opportunity Jan. 24 - to keep inflation right where policy makers want it, analysts said.

Statistics Canada's latest report on inflation showed a small increase over November's rate of just two per cent, although financial markets were less certain about the pace at which rates will continue to rise.

By late Wednesday morning, traders had pushed the dollar down as much as 0.82 of a cent from Tuesday's close to 85.19 cents US on concerns the central bank won't hike rates as high as some had previously thought.

"The market is starting to get the idea of pricing out some of the interest rate hikes that they had priced in by the Bank of Canada," said Andrew Busch global market strategist at Harris/Nesbitt.

"I think maybe down the road, inflation numbers today may cause the BoC to think about pausing, maybe one or two hikes down the road," Busch said, adding that many had looked for three more increases.

For 2005 as a whole, inflation averaged 2.2 per cent, the agency said Wednesday.

Stronger gas prices at the pump were key a contributor to higher annual inflation in December - they jumped by fully 14.5 per cent last month compared with December 2004.

But on a month-over-month comparison, energy prices have actually softened through last fall and early winter.

That suggests inflation isn't a serious concern - and the central bank is aiming to keep it that way.

"There's nothing here to change my view that the Bank of Canada is going to keep on tightening over the next three fixed announcement dates," by quarter-point increments, said Marc Levesque, chief strategist with TD Securities.

"Another rate hike next week is practically in the bag."

The Bank of Canada raised its key policy interest rate three times last fall to its current level of 3.25 per cent.

Several analysts have predicted it will continue tightening until its key overnight rate reaches at least four per cent.

The latest inflation report showed the core rate - which excludes many volatile food and energy items and is most closely tracked by the central bank - slipped slightly to 1.6 per cent in December.

That's well within the central bank's target range of one to three per cent and won't slow interest rate hikes because the underlying price pressures are still quite powerful in a growing economy, said Levesque.

Evidence of the country's economic strength came earlier this week in the Bank of Canada's regular business outlook survey, which found many Canadian businesses say they're operating at almost full speed and would have trouble expanding sales.

Most are also feeling upbeat about future prospects and some have reported trouble finding enough workers.

South of the border, American inflation climbed by more than expected in December to an overall rate of 3.4 per cent.

The U.S. Labour Department said the increase reflected a surge in energy costs.

Analysts say it could be enough to convince the U.S. Federal Reserve to raise interest rates there for the 14th time on Jan. 31.

Policy makers in Canada closely track conditions in the United States - by far, this country's largest trading partner.

Energy costs were less of a problem in Canada, with StatsCan reporting December prices were somewhat lower compared with one month earlier.

Natural gas prices fell by 6.1 per cent last month compared with November; fuel oil was 4.9 per cent cheaper and gasoline as well as electricity also were slightly less expensive in December.

That follows a year of "absolutely wild gyrations" in energy prices, which led some to predict those would eventually spill over into a higher core rate - a fear that didn't ultimately come to fruition, said Doug Porter, deputy chief economist at BMO Nesbitt Burns.

In the end, Canada's annual inflation rate averaged just 2.2 per cent for the entire year, matching the December figure, he noted.

"So when all is said and done, there was a lot more said than done on the inflation front," said Porter.

Restaurant meals and homeowner replacement costs also contributed to a higher cost of living last month.

Those expenses were slightly offset by lower costs for computer gear and fresh vegetables in December, said Statistics Canada.

The agency also reported the country's factory shipments unexpectedly fell in November by the largest amount in more than half a year.

Slower energy and auto sales reduced shipments by about 1.5 per cent to average $51.4 billion.

Source: Canadian Press

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