Canada's Housing Bubble

March 19, 2010 Greg Quinn Bloomberg

Canada’s core inflation rate unexpectedly accelerated last month on higher costs for automobile insurance and accommodation during the Vancouver Winter Olympics, pressuring the central bank to increase interest rates.

Annual inflation excluding eight volatile items quickened to 2.1 percent in February, the fastest since December 2008, compared with 2 percent in January, Statistics Canada said today. Economists predicted a 1.7 percent pace, based on the median of 19 estimates gathered by Bloomberg News.

The economy is accelerating out of last year’s recession, with retail sales data today also rising faster than expected, similar to recent reports on growth and manufacturing. The rebound may change how fast Governor Mark Carney raises the central bank’s record low 0.25 percent benchmark interest rate, which he’s promised to keep in place through June unless the inflation outlook changes to support the recovery.

“Inflation has been much stickier than the Bank of Canada anticipated and the economy is starting to roll,” said David Watt, senior currency strategist in Toronto at RBC Capital, a unit of Canada’s biggest bank. “Overall, the Bank of Canada has no flexibility left and would be justified in highlighting the risk of an early move.”

Carney has a chance to comment on the economy and the recent move in the Canadian dollar close to parity with the U.S. dollar in a speech and a press conference scheduled for March 24. The central bank’s next interest-rate decisions are scheduled for April 20, June 1 and July 20.

Higher Swap Rates

The six month overnight index swap rate, a measure of the average overnight rate expected by investors during that time, jumped to 0.375 percent from 0.353 percent yesterday. It rose as high as 0.395 percent, the highest in a year.

Overall consumer price inflation was also faster than expected, advancing 1.6 percent in February from a year earlier. Economists forecast the pace would slow to 1.4 percent from January’s 1.9 percent.

“Everyone is shocked at the strength in inflation,” said Eric Lascelles, TD Securities Inc.’s chief economist and rates strategist in Toronto who predicts the central bank will raise rates in July. He said inflation looked stronger in February than it really was because of the impact of the Olympics.

“This is one the market is struggling to interpret properly,” he said. “The reality is that the sustainable trend in inflation is not really any different than it was before.”

Bank Prediction

The bank predicted in January that core inflation would average 1.6 percent in the first quarter, and not reach 2 percent until the third quarter of next year.

Traveler accommodation costs jumped 16 percent in February, Statistics Canada said, while automobile insurance premiums increased 7.9 percent. The year-over-year increase in gasoline prices was 15 percent, slower than January’s 24 percent jump.

Excluding the accommodation cost increase tied to the Olympics, core inflation rose about 1.8 percent from a year earlier, according to Paul Ferley, assistant chief economist at Royal Bank of Canada and Doug Porter, deputy chief economist with BMO Capital Markets.

On a monthly basis, core consumer prices rose 0.7 percent, the fastest since November 2008, and overall inflation was 0.4 percent. Economists predicted the monthly rates would be 0.3 percent for both total and core inflation.

Core Inflation

The central bank’s main goal is keeping the overall annual inflation rate at 2 percent. It focuses on the core measure because that excludes volatile items that can generate short- term swings in inflation.

“Core inflation has been slightly firmer than projected, the result of both transitory factors and the higher level of economic activity,” the central bank said in its March 2 rate decision.

The economy grew at a 5 percent pace in the fourth quarter, the fastest since 2000, according to Statistics Canada. The economy shrank for three straight quarters through the middle of last year, the first recession since 1992.

Retail sales rose 0.7 percent in January, as consumers stocked up on home improvement supplies before a federal tax credit expired, Statistics Canada also said today. Reports over the last week have also shown wholesale sales rose at the fastest pace in three years in January, and a gain in factory sales that was four times what economists predicted.

Faster growth can trigger cost increases. Toronto’s commuter railway operator, GO Transit, will raise all of its adult single-ride ticket prices by 25 cents tomorrow to cover operating costs and improve service.

Still, the central bank has predicted that the economy will operate with “slack” through the middle of 2011, and that growth will be restrained by a strong Canadian dollar and a low volume of U.S. orders.