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File photo of a gasoline station in Montreal.Christinne Muschi/The Globe and Mail

Canada's economy slowed to stall speed at the end of 2012, putting pressure on the Bank of Canada to extend a period of ultra-low interest rates that already has been locked in for more than two years.

Retail sales plunged 2.1 per cent in December, Statistics Canada said Friday, surprising many Bay Street economists who assumed the allure of the holiday shopping season would have offset the damping effects on household spending of stagnant wages and record-levels of debt.

A separate Statscan report showed annual inflation at a mere 0.5 per cent in January, marking the smallest 12-month increase in consumer prices since October, 2009, and contributing to the prevailing sentiment that Canada's economy, once the envy of the industrial world, suddenly is standing still.

The Canadian dollar fell 0.2 of a cent, to 97.96 cents U.S., on Friday, while the S&P/TSX composite index advanced 61.65 points to 12,701.63.

The decline in retail sales in December was the biggest in almost three years; combined with previously reported drops in wholesale sales, factory shipments and housing starts, it all but assures Canada's gross domestic product contracted in the final month of 2012.

"It's an ill omen," said David Watt, chief economist at HSBC Bank Canada in Toronto.

Statscan is scheduled to release GDP figures for December and the entire fourth quarter on March 1.

Mr. Watt said in an analysis of the retail figures that his already bleak short-term economic outlook probably now is too optimistic. He predicts Canada's economy contracted by at least 0.2 per cent in December, and that GDP grew at an annual rate of about 0.6 per cent in the fourth quarter.

Such a result would confirm that Canada failed to exceed a growth rate of 2 per cent at any point last year.

That would be a weaker starting point for 2013 than the Bank of Canada was counting on only a month ago, when policy makers indicated they no longer were inclined to raise borrowing costs to deflate the housing market and curb household borrowing.

In its latest quarterly report on the economy, the central bank estimated that Canada's economy grew at an annual rate of 1 per cent over the final three months of 2012, representing a modest rebound from 0.6 per cent in the third quarter.

The Bank of Canada said that its new projections meant an interest-rate increase was "less imminent." Most Bay Street and Wall Street analysts now say Canada's benchmark rate will stay at 1 per cent well into 2014. And Jimmy Jean, an economic strategist at Desjardins Capital Markets in Montreal, said it would be a mistake to rule out an interest-rate cut.

"We do not recollect seeing such uniformly unsightly indicators ever since the Great Recession," Mr. Jean informed clients in a research note. "Markets, with perhaps the exception of the loonie, have stubbornly failed to account for the slimmest possibility of eases, despite glaringly disappointing data."

The inflation figures leave the Bank of Canada with lots of room to manoeuvre. The central bank sets interest rates to achieve annual inflation of about 2 per cent. The 0.5 per cent rate in January is well short of the central bank's fourth-quarter inflation forecast of 1.1 per cent.