* Carney says inflation to stay above 3 pct in short term
* Says cannot shift policy around short-term movements
* Markets pare back rate hike expectations in second half
* Warns of FX volatility due to shifting capital flows (Adds analysts, details)
By Randall Palmer and Louise Egan
OTTAWA, May 16 (Reuters) - Canadian inflation will stay above the central bank’s target range in the second quarter, Bank of Canada chief Mark Carney said on Monday, while appearing to be in no rush to raise interest rates to keep prices in check.
Carney said inflation would remain above 3 percent, surpassing the bank’s target range of 1 to 3 percent and overshooting the bank’s forecast of 2.7 percent average inflation in the second quarter.
But he suggested that price pressures were temporary, the result of gasoline-price increases and provincial tax hikes, and that food inflation had seeped into the country sooner than expected.
“Over the balance of this quarter we do expect inflation to be above 3 percent — that’s total CPI inflation. That’s ... largely driven by two factors: first is provincial taxes .... then secondly, energy prices, particularly gasoline prices,” he said.
“The management of policy cannot be swung around for very short-term movements, particularly in an economy where inflation expectations are very well-anchored.”
He said headline inflation and a “subdued” core inflation will converge at 2 percent by mid-2012, as the bank projected in April.
In a speech in Ottawa he broke no new ground on monetary policy and left market players betting that the central bank will raise interest rates in July or after, with no move on rates at the bank’s May 31 policy-announcement date.
“This does not sound like a central bank poised to do anything soon,” said Michael Gregory, senior economist at BMO Capital Markets.
David Tulk, chief macro strategist at TD Securities, maintained his forecast of a July rate hike but said he was concerned about “the litany of downside risks” highlighted by Carney. “Should these risks remain in place, the confidence we have in the July move will be reduced.”
The Bank of Canada became the first in the Group of Seven advanced economies to begin raising interest rates last year, increasing borrowing costs three times. But it has held its key rate steady at 1.0 percent since September.
Swap markets based on the outlook for Canadian interest rates showed that after Carney’s comments traders slightly trimmed their bets on the likelihood of rate hikes at bank policy-announcement dates in July, September, October and December. BOCWATCH
Further dampening any hawkish sentiment, Carney emphasized in his speech the risk to the Canadian economy from the country’s strong currency and warned of spillover effects if the United States, Britain and others delay fixing their debt problems.
He repeated an April statement that the bank’s decision to leave interest rates at 1 percent “leaves considerable monetary stimulus in place, consistent with achieving the 2 percent inflation target in an environment of material excess supply in Canada.”
Carney also said that recent commodity price declines notwithstanding, the demand for commodities could be expected to remain robust for some time.
“Even though experience suggests that all booms are finite, this one could go on for some time,” he said, adding that recent declines were “fluctuations around high levels”.
However, while higher commodity prices boost profits, production and investment in Canada’s primary sector, the country will not benefit to the same extent as it has in past commodity booms that were driven by U.S. growth, he said. Higher prices act as a net brake on U.S. growth, and “the effect is material”.
The strong Canadian dollar “could create even greater headwinds for our economy, putting additional downward pressure on inflation”.
Carney also warned of excessive foreign exchange and financial market volatility if investors seeking more emerging-market exposure shift capital into Canada and Australia, seen as emerging market proxies because of their strong commodity sectors. (Additional reporting by David Ljunggren, Ka Yan Ng, John McCrank and Alastair Sharp; editing by Peter Galloway)