Bank of Canada warns on inflation rate

Charles Freedman, deputy governor of the central bank, said higher prices for electricity, oil, and auto insurance premiums have boosted the consumer price index in recent months and higher grain prices will add more pressure, the Financial Post reported.

"Given that some of these shocks are likely to be persistent, core and total CPI will likely remain higher than previously anticipated through to about the middle of 2003," Mr. Freedman told the Mississauga Economic Advisory Council.

The total CPI rose 2.6% year-over-year in August, up from 2.1% in July, while core inflation, which strips out the eight most volatile items, rose 2.5% from 2.1% in July. The core rate, which the bank uses as its operational guide for adjusting interest rates, has remained above 2% -- the midpoint of the bank's 1% to % target band -- in all but three of the past 17 months.

Mr. Freedman said that in addition to recent upward price shocks, the CPI will be affected by what the bank calls the "fourth-quarter echo" effect. Heavy price discounting in response to the Sept. 11 terrorist attacks have been unwound, so the year-over-year change in prices will show a rise.

In an interview before his speech, Mr. Freedman brushed aside growing fears of deflation in the United States. Some have wondered why the Bank of Canada should worry about inflation when the biggest threat facing its biggest trading partner could be deflation.

"If the U.S. economy turns out the way, for example the IMF says, which is slightly lower than the consensus -- most people are talking about 3% growth next year -- this is not an economy that is going to have deflation," he said. "But ... we make decisions based on what's going on in Canada, and inflation is somewhat above the mid-point of the band at the moment. Our economy has been doing very well ... and so we just have to make decisions based on what 's going on in Canada."

In addition to comments on inflation, Mr. Freedman said two main concerns continued to preoccupy the bank.

"Domestic demand may well be stronger. At the same time, the external uncertainties bearing on the outlook appear to be greater than they were in early July," he said, referring to the bank's last detailed view of the economy.

He said it was still the bank's plan to continue raising interest rates but such external risks as stock market volatility and geopolitical tensions meant any tightening would have be administered in a "timely" and "measured" fashion.

Doug Porter, senior economist at BMO Nesbitt Burns, said Mr. Freedman's focus on inflation in the speech indicated the August surge clearly "rattled a few windows."

"The Bank of Canada had to respond to that number," he said. "It seems like the bank is taking it in stride and focusing on the medium-term view. But they're looking less confident with each speech and report."

Nevertheless, Mr. Porter was hesitant to say the focus on inflation meant the bank would raise its overnight target from 2.75% on 16 October.

"The main message is that rates have to go higher but they're trying not to put too much of a timeline on it and it doesn't have to happen this month," he said.