Core inflation rate surges on impact of weaker loonie

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The chances of another Bank of Canada interest-rate cut took a step backward following two key economic reports Friday, as higher-than-expected inflation and a sharp rebound in retail sales suggested the Canadian economy may be weathering the oil shock better than thought.

Statistics Canada reported the annual inflation rate was 1.2 per cent in March, up from 1.0 per cent in February and the highest level since December, as the impact of the weaker loonie and a rebound at the gas pumps pushed consumer prices higher. The Bank of Canada's closely watched core inflation rate, which excludes some of the most volatile components of the Consumer Price Index (CPI) to provide a better picture of the underlying inflation trend, surged to 2.4 per cent – its highest level in more than six years.

Meanwhile, Statscan also reported that seasonally adjusted retail sales surged 1.7 per cent month over month in February.

February's retail numbers were a bounce back from January's decline. While higher gasoline prices were a factor, the gains were widespread, with 11 of 12 sectors rising. On a volume basis, excluding price effects, retail sales were up a strong 1.3 per cent in the month."Today's data suggest that the Bank of Canada's zero-per-cent first quarter [growth] forecast is maybe too pessimistic," said CIBC World Markets economist Nick Exarhos in a research note. "A second cut from [Bank of Canada Governor Stephen] Poloz is now that much less likely."

Statscan said that on a year-over-year basis, food prices (up 3.8 per cent) have been the main upside driver. Gasoline prices have been the biggest downward drag on year-to-year inflation, down 19.2 per cent; but they have rebounded 16 per cent in the past two months, reducing the oil-related drag on the annual inflation rate.

Economists had expected both total and core CPI inflation to hold steady at 1.0 per cent and 2.1 per cent, respectively, but were surprised by unexpectedly strong price gains in March. Both total and core CPI jumped 0.4 per cent in March on a seasonally adjusted basis over February, their biggest month-to-month advance in more than two years. Transportation costs led the advance, reflecting a 6.3-per-cent rise in gasoline prices. But the increase was broadly based, with six of the eight major component sectors in CPI higher on the month.

The core CPI measure is now at its highest level since the end of 2008, and has spent the past eight consecutive months above the Bank of Canada's 2-per-cent target that guides its interest rate policy.

But earlier this week, the central bank noted in its quarterly Monetary Policy Report that the core inflation rate is being elevated by several "temporary" factors, including a deepening impact from the depreciation of the Canadian dollar, which by the end of March had lost about 15 cents against its U.S. counterpart over the previous nine months. It estimated the pass-through effects of the weaker currency are adding 0.3 to 0.4 percentage points to the core inflation rate. Other temporary factors, especially higher prices for meat and communications services, are adding about another 0.2 percentage points, it said.

"There were rampant signs of currency pass-through scattered across this [Statscan CPI] release," said Douglas Porter, chief economist at Bank of Montreal, in a research report. "The recent rebound in the Canadian dollar – it's up 4 per cent from its March average level – will take some steam out of import prices, which clearly have been the big driver of core."

Still, the strong core rate suggests inflationary pressures are more broadly based than just a food-and-energy phenomenon. Statistics Canada noted that excluding food and energy, consumer prices were up 2.0 per cent from a year earlier, which matches a four-year high. Just excluding energy, CPI was up 2.3 per cent year over year, which also matches the fastest pace in nearly four years.

Dawn Desjardins, assistant chief economist at Royal Bank of Canada, noted nearly half the components of CPI are showing year-over-year gains above 2 per cent, "indicating that price pressures are spreading beyond items that are exchange-rate sensitive."

"Core price resilience suggests the Canadian economy had less slack prior to its deceleration in the first quarter than the central bankers believed," Mr. Exarhos added.

If the inflation data suggest the Bank of Canada may not need further easing to spur inflation to sustainably achieve its 2-per-cent target, the retail numbers suggest the economy may have been stronger in February than many observers, including the central bank, had feared. Given that February was a particularly harsh month for winter weather, the broad advance in retail sales was an encouraging sign for consumer appetite at a time when other segments of the economy showed signs of suffocating under the snow pack.

"Today's data are likely to save February's monthly GDP outlook," Mr. Exarhos said.