Softer-than-expected inflation data for December have reinforced the view the Bank of Canada will remain sidelined on raising interest rates until at least the second quarter, weighing on the Canadian dollar and pushing bond yields down.
The data come in marked contrast to signs of simmering inflationary pressures in many other countries and reflect that underlying price pressures remain contained in Canada, analysts said.
As a result, there's little pressure on the bank to start tightening policy soon, with the next move in its stalled tightening cycle likely at its fourth policy date of the year in May, Buchanan said.
The data are also consistent with a pattern of year-end softness in the Canadian consumer price index, which is not seasonally adjusted.
Canada's all-items consumer price index rose by 2.4% in December on a year-over-year basis, while the core index was up 1.5%. Economists had expected all-items CPI to rise by 2.5% on annual basis and the core index by 1.6%.
So far, the damage to the Canadian currency has been contained as the data didn't stray far from forecasts, and are not likely to trigger a big shift in expectations for monetary policy.
The Canadian dollar was significantly lower early Tuesday afternoon, with the U.S. dollar at C$0.9990 from C$0.9949 late Monday, according to data provider CQG. The U.S dollar reached a session high C$1.0006 Tuesday morning before paring some of its gains.
Instead, the inflation report is cementing expectations the Bank of Canada will remain sidelined at its next two policy sessions on March 1 and April 12. Analysts see a strong chance of a rate increase at the May 31 policy date, but some expect it to wait until the second half of the year.
The bank left its key overnight target rate at 1.00% last Tuesday as expected, but surprised the market by its cautious stance on monetary policy.
BMO Capital Markets said the major theme in Canada's December inflation data is that underlying inflation trends are still quite muted, especially in the face of heavy increases in gasoline prices, the lingering impact of revamped sales taxes in some provinces last year and the global upswing in food costs.
"While these factors are likely to keep average inflation a bit above 2% in 2011, core inflation looks set to remain comfortably docile around current trends through much of the year," BMO said.
The Bank of Canada's key policy objective is to keep inflation near its 2% target.
Even food prices showed contained increases in December despite rising prices globally, recording a 1.7% year-over-year increase.
Even then, the tightening will likely come in response to improving growth data rather than any immediate concern with inflation, he said.
The bank raised its overnight target rate by a total of 75 basis points last year, the first central bank among the Group of Seven industrialized nations to do so. It put its tightening program on hold in October because of uncertainties in the U.S. and global outlook and slowing domestic growth.
BMO said it appeared unlikely anyone would change their forecast on the policy outlook at the Bank of Canada on the data, but the report "strengthens the case the bank can take its time before hiking rates again."
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