Loonie dips, interest rate fears subside with annual inflation rate steady in July

OTTAWA (CP) - Canada's annual inflation rate rested at 2.2 per cent in July, the same level it has held since April, further reducing the likelihood of any interest rate hikes. Statistics Canada said Tuesday that higher housing costs were the main driver of inflation in the consumer price index.

Mortgage interest costs alone jumped six per cent between July 2006 and last month, the largest increase since 2000. Without mortgage costs, the inflation rate would have been 1.9 per cent.

The Bank of Canada's "core" inflation rate, which strips away volatile factors to look at underlying inflationary pressures in setting interest rates, slipped to 2.3 per cent from 2.5 per cent in June. The bank's target for core inflation is two per cent.

Analysts said Tuesday's report will give the bank more breathing room for its September decision on interest rates. In the ongoing credit crunch, a lending rate increase has become much less likely.

"I don't believe that in current market conditions that raising interest rates is in anyone's best interests," said Aron Gampel, deputy chief economist at Scotiabank.

As markets digested the data, the loonie slipped 0.41 of a cent to 94.46 cents US after rising 0.65 of a U.S. cent Monday. Gampel said the dollar is buffeted by other factors beyond inflation, however.

"The currency is extremely volatile right now and I think that is a reflection of the instability in the marketplace and the fact that commodity prices have dropped a bit."

Douglas Porter of BMO Economics said the central bank will like the inflation data.

"This benign result is clearly good news for the Bank of Canada and will give them greater comfort as they wait on the sidelines for the storm to pass at the Sept. 5 decision date (on interest rates)," he said.

He said the core rate seems under control.

"While we've seen temporary dips before in Canadian core inflation in the past two years, only to see it come roaring back even stronger than before, it appears that trends will remain moderate for a few months yet."

Beata Caranci, director of economic forecasting at TD Bank, said the interest rate respite could be short-lived if financial turmoil ebbs.

"If recent central bank moves to prop up liquidity prove successful in returning stability to financial markets and easing credit constraints, the central bank could very well return to the table with a 25-basis-point rate hike on Oct. 16," Caranci said.

Royal Bank said the central bank has to look at underlying pressures.

"Since the economy is on track to record a second consecutive quarter of above-potential growth, the Canadian economy is increasingly operating in a state of excess demand," Royal Bank said.

"And, with the unemployment rate edging down to six per cent in July and wage growth accelerating, Canada's inflation rates are on track to remain above the bank's target."

The rising cost of home ownership - mortgage costs and replacement costs - contributed the most to inflation in July, while cheaper gasoline and computer equipment and supplies helped dampen prices.

On a month-to-month basis, prices edged up 0.1 per cent between June and July .

Higher prices for women's clothing, traveller accommodation and higher mortgage interest costs in July were largely offset by lower prices for cars and trucks, natural gas and fresh vegetables.

Higher property taxes and rents also helped push up the overall inflation rate.

Food costs were up 2.7 per cent last month, but that was the slowest pace in six months.

© The Canadian Press, 2007