* Overall inflation 2.3 pct in May, core 1.7 pct
* Economists expect less BoC talk about weak inflation
* Rate hike seen sooner than later - but not now
* C$ rises to five-month high, bonds sharply lower
(Recasts with analyst comment, context about pressure on
central bank, market reaction)
By Randall Palmer
OTTAWA, June 20 The Bank of Canada came under
pressure on Friday to stop fretting about low inflation after
unexpectedly sharp price gains pushed the rate above the central
bank's target, making it more likely the next move in interest
rates will be higher.
Statistics Canada reported the annual inflation rate hit a
27-month high of 2.3 percent in May from 2.0 percent in April.
Core inflation, which excludes some volatile items like
gasoline, rose to 1.7 percent, the highest since July 2012, from
1.4 percent in April.
As recently as last week, Bank of Canada Governor Stephen
Poloz had said the underlying rate of inflation, which he pegged
at 1.2 percent, was so low it "leaves us vulnerable to a
downside shock at any time."
The central bank aims for 2 percent inflation and to keep it
within a range of 1 to 3 percent. While acknowledging higher
inflation readings in its June 4 rate statement, it said
increased risks to growth left "the downside risks to the
inflation outlook as important as before."
But economists said on Friday that position was becoming
increasingly untenable and said a change in language would be in
order, though nobody expects an immediate rate hike.
"The low-inflation ship has sailed in Canada, and I think
the Bank of Canada pretty much has to change their rhetoric as
of the next meeting," said Bank of Montreal chief economist Doug
It may be tricky for the central bank to shift its tone
without at the same time causing a strengthening in the Canadian
dollar that would hurt exports, similar to sterling's strong
rise when Bank of England Governor Mark Carney said last week
rate hikes could happen sooner than expected.
National Bank Financial senior economist Krishen Rangasamy
believes the Bank of Canada, formerly headed by Carney, will
want to downplay inflationary pressures and reductions in the
output gap "so as to keep the Canadian dollar weak."
"I think they are going to keep spinning that story as long
as they can, to keep the Canadian dollar from heading back
towards parity. They definitely do not want that to happen
because that could choke off the recovery in exports," he said.
Poloz has repeatedly said the central bank targets inflation
and not the currency, but has also expressed disappointment with
The Canadian dollar rose to a 5-1/2 month high on the
inflation data, and on an accompanying report showing retail
sales in April rose nearly twice as fast as expected.
Canada was the first among the Group of Seven leading
industrialized nations to raise its policy rate after the
2008-09 recession but has kept it at 1 percent since September
Poloz has said the central bank's policy stance was neutral,
specifying that rates could just as easily fall as they could
rise, using dovish language that has kept a lid on rate hike
expectations and the currency.
Still, yields on overnight index swaps show rate cut
expectations have largely faded.
And even before Friday's data economists were unanimous that
the next rate would be a hike.
MAKEUP OF INFLATION
The median forecast in a Reuters poll of 38 economists
released on May 29 was for the Bank of Canada to raise its rate
in the third quarter of 2015, with no one expecting a hike this
"We are still of the view that any moves on rates are not
likely until 2015, but certainly there is now a higher
probability of hikes coming sooner rather than later," said
Royal Bank of Canada assistant chief economist Paul Ferley.
May's inflation readings were well above the second-quarter
projection the Bank of Canada made in April of only 1.6 percent
overall and 1.2 percent for core.
Last month's inflation rate also was the highest since the
2.6 percent reported for February 2012.
The year-over-year rise in prices was led by an 8.4 percent
jump for energy, including 6.3 percent for gasoline, 21.3
percent for natural gas and 7.0 percent for electricity.
Porter said the bank believed the drop in the Canadian
dollar over the past year might have added 0.2 percentage points
to core inflation recently.
"I think there is more to this than just food, energy and
the Canadian dollar. I do think inflation is starting to creep
back up again," Porter said.
Indeed, the monthly rise in core inflation was identical to
the rise in overall prices, 0.5 percent.
(Additional reporting by Allison Martell, Euan Rocha and
Alastair Sharp in Toronto; Editing by Jeffrey Hodgson and Paul