What’s up with Inflation in Canada?

Apparently, core inflation in Canada dropped to the lowest level in the past couple of years. Why? According to Statistics Canada, this is because Canadian car dealers, in order to compete with the now cheaper cars sold in the U.S. (because of the soaring loonie, weak auto sector, and all that), had to slash their prices just to stay somewhat competitive. This is just one more indicator that rising price levels are not an issue in Canada.

As far as other prices in the consumer basket are concerned, those dropped down from 2.5% in November to 2.4% in December. Core prices, which do not include most of the volatile items in the index, increased, but at a less-than-expected rate of 1.5%.

This information was released a day after the Bank of Canada announced that it expects core inflation to dip below 1.5% after the second quarter to give enough time for retailers to adjust their prices to the stronger dollar, and for the GST cut of one percent in 2008 to be fully factored in.

Just to give an idea, sector by sector, according to Statistics Canada, prices of vehicles sold and leased in Canada dropped 4.1% in December. This percentage drop effectively brought Canadian prices more in line with U.S. prices. Fresh fruit and vegetable items also dropped significantly, with oranges and apples leading the way at price drops of 15.8% and 13.1%, respectively. Computer prices lost ground, too, particularly laptops, while liquid crystal display (LCD) screens were very close behind. In addition, books, excluding textbooks, and other printed materials lost 7.7%.

However, the offsetting upward pressure came from more expensive real estate and energy costs. To illustrate, prices at your friendly neighborhood gas pump jumped 14.9% from December 2006 to December 2007. Notably, gas prices carry approximately five percent weight in the CPI basket. Home loan interest costs were also wielding inflationary pressures, rising 7.3% in December. Prices of restaurant food and baked goods at grocery stores were also up.

The Bank of Canada is usually watching for this report very closely, because it largely determines the direction interest rates are to take. With falling price levels, if we were to live in a vacuum, our central bank could be inclined to keep interest rates steady or even increase them to ward off some form of a deflationary effect. However, with the slowing U.S. economy very much on its mind, the Bank of Canada is most likely looking into decreasing interest rates, since at least inflation is one less worry on its plate.