Inflation slows to 1.5% on plunge in gas prices

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Canadian consumer prices crumbled under the weight of falling oil prices in December, as the country posted its slowest rate of inflation in nine months.

Statistics Canada reported Friday that the consumer price index was up 1.5 per cent year over year in December, down sharply from 2.0 per cent in November. The downturn was not unexpected, as plunging fuel prices in the month had promised to take a big bite out of the index. On a month-over-month basis, CPI slumped 0.7 per cent.

Statscan said gasoline tumbled 9.8 per cent in December from November, and was down 16.6 per cent from a year earlier. Gasoline alone makes up nearly 5 per cent of the consumer price index, so its decline accounted for most of the monthly drop in CPI.

Nevertheless, the core CPI measure, which excludes the most volatile components including many fuels and food products, was up 2.2 per cent year over year – a slight increase from 2.1 per cent in November. The core rate is relied on more closely by the Bank of Canada in guiding interest rate policy, because it is considered a more reliable indicator of the economy's broad underlying inflationary pressures. The core rate came in just a shade below economists' expectations of 2.3 per cent.

While prices for clothing and footwear, recreation and education, and alcohol and tobacco all fell in December, overall prices were propped up by food (0.4 per cent month over month) and shelter (0.2 per cent), two of the biggest segments of the index. Shelter accounts for more than one-quarter of CPI, while food makes up about 16 per cent.

Consumer Price Index, with and without gasoline

This week, as it made an unexpected cut to its key interest rate, the Bank of Canada warned that the total CPI inflation rate could fall as low as 0.3 per cent in the second quarter of this year, well below the bottom end of the bank's 1-to-3-per-cent target range, as the full year-over-year impact of the fuel price drop sinks in. However, the bank believes that despite spillover effects to other parts of the economy, core inflation will dip only slightly below the 2-per-cent midpoint of its target range throughout the year.

But economists didn't see much in the December inflation data to heighten their concern. They said that outside of the oil shock, Canadian price pressures have been gradually building in recent months.

"Since August, there has been a persistent broadening out of inflation pressures with 43 per cent of the components of the CPI posting gains of at least 2 per cent in December," said Dawn Desjardins, assistant chief economist at Royal Bank of Canada, in a research note. "In the Monetary Policy Report issued earlier this week, the Bank of Canada acknowledged that 'underlying' price pressures have been drifting higher."

Nevertheless, the central bank is concerned that the economic drag caused by a weakening oil sector, and the resultant fallout in lower incomes, investment and hiring, pose a risk of lower inflationary pressures in the coming months. Bank Governor Stephen Poloz described the rate cut as taking out "insurance" against such downside risks.

Douglas Porter, chief economist at Bank of Montreal, noted that consumer price declines in December are fairly typical, due to holiday-season discounting by retailers. On a seasonally adjusted basis, total CPI dipped a modest 0.1 per cent month over month, while core CPI actually rose 0.2 per cent.

"With the Canadian dollar's deep decline pressuring prices on anything imported and consumer spending holding up well, we would look for core CPI to hang around the 2 per cent level for some time yet," he wrote in a research note. "Note that over the past 20 years, there is zero correlation between energy prices and core CPI in Canada, so we do not expect the plunge in oil to materially affect underlying inflation trends, especially with the weak loonie driving up many prices."

Separately, Statscan lent support to that strong-consumer-spending theme, as it reported retail sales rose a stronger-than-expected 0.4 per cent in November from October. Excluding automobiles and gasoline, sales were up 1 per cent in the month.

"Today's inflation report does not indicate any slippage in underlying inflation pressures in the latter part of 2014, and our assessment is that if the economy maintains its momentum in the first half of the year, the core measure won't move down materially," Ms. Desjardins said. "Against that backdrop, the Bank of Canada is unlikely to see the need for rates to move lower, although will likely maintain its 'insurance' policy rate cut and keep the overnight rate at 0.75 per cent at least through the end of this year."