Inflation decline to impact Bank rate

Anyone collecting—or administering—an indexed pension plan should be keeping tabs on the consumer price index (CPI), but the latest reading could also have an impact on investment decisions.

Statistics Canada said Friday that the CPI rose at an annual pace of 2.7% in July, down from a 3.1% rate in June. That gives the Bank of Canada (BoC) room to keep interest rates at their exceptionally low levels.

July was the first time that inflation has been below a pace of 3% since February. TD Bank deputy chief economist Derek Burleton said the “inflation genie” appeared to remain tucked in the bottle.

“It will give the Bank of Canada some wiggle room to keep rates low during this period of global uncertainty,” Burleton said.

Not long ago, most economists were predicting the BoC would raise rates as early as September. But those forecasts came before the U.S. Federal Reserve announced it would maintain its extremely lax monetary policy until at least 2013.

“The thinking has shifted now to the fact that economic growth is probably going to slow, and the fact that core inflation is still below the Bank of Canada’s target [of 2%] means that inflation really isn’t a major risk at the moment.”

The core index, which is used by the BoC to help guide its decision on interest rates, gained 1.6% following a 1.3% gain in June. On a month-over-month basis, the core index was up 0.2% in July, in line with economist expectations.

“The BoC can only be pleased with these numbers,” commented Benoit Durocher, senior economist with Desjardins Financial Security. “Total inflation is down, so a return to the median target is likely within a few months, and core inflation is relatively stable. Given the net slowdown in economic growth we are seeing now, inflationary pressures are clearly fading. This gives the monetary authorities plenty of leeway for managing the country’s key interest rates.”

BoC governor Mark Carney told the House of Commons finance committee that the latest read on inflation was consistent with the central bank’s expectations.

Finance Minister Jim Flaherty and Carney testified before the committee on Friday following nearly two weeks of volatile trading on stock markets around the world due to fears of a sovereign debt crisis in Europe and worries that the U.S. may slip back into recession.

As the Canadian recovery has progressed, the central bank has emphasized that it would be prudent with respect to the possible withdrawal of any degree of monetary stimulus, Carney said.

“This is particularly important in the current environment of material external headwinds. To state the obvious, if the outlook for growth and inflation changes, the path for monetary policy will be affected accordingly,” he said.

BMO senior economist Sal Guatieri noted that the core rate appeared to be on track to fall short of the BoC’s estimate of 1.9% for the third quarter.

“While Canadian inflation has been more volatile than usual of late, core inflation looks to settle just below the 2% inflation target, providing an anchor for the headline rate to gravitate toward,” Guatieri wrote in a note to clients.

“The tame core reading will buy the Bank of Canada time to remain on the sidelines and is clearly no obstacle for rate cuts should global recession risks intensify.”