• All items inflation edges down to 2.4%; core drops to 1.5%
• More easing expected from the Bank of Canada as core inflation falls below target for the third straight month.

Consumer price growth eased in December, falling to 2.4% from 2.5% in November, in line with expectations. Core inflation came in below expectations at a pace of 1.5%, following 1.6% last month. Core consumer price growth decelerated for the seventh straight month to its slowest pace since December 2005. For 2007 as a whole, prices were up 2.2%, up slightly from 2.0% in 2006.

The easing of price growth in December once again reflected the competitive pressures on retailers due to the higher valued Canadian dollar. Both non-durable and durable goods price growth decelerated in December with the largest downward pressure from motor vehicles, which fell 4.1% from last year. Inflation was kept up mainly by gasoline prices (+14.9%) and homeowners replacement costs (+4.4%). However, on both of these fronts, the risks going forward lay to the downside. Growth in homeowner replacement costs (estimated using new home prices) is likely to decelerate further in the coming months as Canada’s housing market continues to cool, especially in the hottest markets in the west. Higher gasoline prices too seem set ease as they have been kept up by rising crude oil prices in world markets, which now appear to be on a downward trend. The price of crude oil rose through most of December, reaching a high of $100 U.S. a barrel at the beginning of January, but has since fallen to $90 U.S. a barrel. Slower U.S. and global growth will likely continue to exert downward pressure on crude oil prices and we expect to see some narrowing of the gap between core and headline inflation in the months ahead.

Regionally, price growth slowed in 6 of 10 provinces and was flat in Newfoundland and Labrador. Western provinces continued to be hot beds for inflation and it was encouraging that these showed the greatest deceleration in December. Consumer prices were up 4.1% y/y in Alberta, down from 4.7% in November and in Saskatchewan prices increased 3.7%, down from 4.0% in November. Decreases in natural gas prices and a slowdown in the growth of homeowner’s replacement costs were helpful in easing price pressures in the western provinces.

The Bank of Canada’s recent and cautious 25 basis point interest rate cut reflected their view of the Canadian economy continuing to operate above its production capacity. With the risks to the outlook, particularly from the stalling U.S. economy, falling mainly to the downside, their outlook for 2008 now sees the Canadian economy falling into a state of excess supply by the end of 2008. Inflation is well below the Bank’s target for the third straight month and more downward pressure is expected, leaving the Bank with little to worry about on the inflation front and free to step on the monetary stimulus pedal. We expect the bank to ease by 50 basis points at their next meeting in March, followed by an additional 25 basis point cut at their meeting in April.

James Marple, Economist
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