CPI ebbs but annual inflation at 5-year high

OTTAWA (Reuters) - Falling gasoline costs provided some relief to Canadians in August, knocking down consumer prices for the first time since January but annual inflation stayed at a five-year high, likely discouraging the Bank of Canada from cutting interest rates.

The consumer price index dipped 0.2 percent in the month thanks to a 6.6 percent slide in gasoline from record highs, Statistics Canada said on Tuesday. But inflation sped to 3.5 percent on the year from 3.4 percent in July, its highest since March 2003 as energy prices remained sharply above 2007 levels.

The figures were in line with market forecasts.

But core inflation, which excludes several volatile items like gasoline and is the Bank of Canada’s preferred gage of underlying price trends, rose more than expected at 0.3 percent in the month and 1.7 percent year-over-year.

Analysts had expected a monthly rise of 0.1 percent and an annual rate of 1.6 percent, according to median forecasts in a Reuters poll.

“I think the real eye-opener here is core inflation,” said Doug Porter, deputy chief economist at BMO Capital Markets.

On a seasonally-adjusted basis, prices rose 0.2 percent in August from July.

“Overall the report isn’t a big disappointment but it must be mildly troubling for the Bank of Canada,” he said.

The Canadian dollar strengthened after the move, moving to C$1.0342 to the U.S. dollar, or 96.69 U.S. cents, from a pre-data level around C$1.0338 to the U.S. dollar, or 96.73 U.S. cents.

The Bank of Canada, which aims to bring inflation back down to 2 percent by late next year, expects the rate to rise through the remainder of this year as past increases in the oil prices are reflected in the year-over-year comparisons.

In July, the bank forecast total inflation would peak at 4.3 percent in the first quarter of 2009 but has since said the spike would be milder because of the downturn in oil.

However, it expected core inflation of 1.5 percent in the third quarter, suggesting it may be uncomfortable with the rise above that in August.

Markets have priced in a 50 percent chance the central bank will cut its key overnight lending rate by 25 basis points to 2.75 percent on October 21, according to contracts for overnight index swaps.

“If everything else was normal the Bank of Canada might well be worried by a slight upward tick in the core measure, but everything else is far from normal,” said Craig Wright, chief economist at the Royal Bank of Canada.

“I think the near-term considerations for the bank and everyone is to have some sort of semblance of stability to return to the financial markets and assuming we get that we can look back at what to do on risks on inflation and growth.”

Canadian workers, meanwhile, are seeing their wage gains nearly wiped out by inflation, said Erin Weir, economist at United Steelworkers union. Consumer inflation has overtaken wage inflation in Ontario, the province hardest hit by the export-led economic slowdown.

On a 12-month basis, seven out of the eight major components of the index rose, with only clothing and footwear dropping.

Energy prices were 20.2 percent higher in August compared with a year earlier even though they fell 3 percent from the previous month. As a result, transportation costs rose the most from a year earlier at 5.8 percent.

Shelter prices were also up 5.3 percent, driven by rising costs of mortgages and energy associated with housing. More expensive bakery and cereal products pushed up food prices by 4.5 percent, Statscan said.

Additional reporting by Frank Pingue and Jennifer Kwan in Toronto; Editing by Frank McGurty