Canadian consumer prices recovered in July, rising 0.2% following June's unexpected 0.7% drop in the unadjusted index. Despite the monthly increase, the annual inflation rate fell back to 2.7% from 3.1% in June as the jump in the price level that occurred in July 2010 due to the implementation was not repeated. Core inflation, which excludes the eight most volatile items and the effect of changes in indirect taxes, also rose in July by 0.2% following June's 0.6% decline. The annual core rate* rebounded to 1.6% following June's 1.3% print.

(*July 2011 is the first month when the effect of the increase in the HST drops out of the CPI measure. To calculate the core measure, the effect of this tax hike needed to be subtracted from prices requiring an estimate of the pass through by retailers. There is always the risk of a bias entering into the year-over-year rate if too much or too little was subtracted for the past year. The 1.6% increase in core prices would be free of any such bias.)

The components of the July Inflation Report showed higher prices for electricity, traveller accommodation, some food items, and men's clothing. The rise in electricity costs and travel were expected and reflect seasonal pressures. Gasoline prices posted a modest 0.5% decline in the month. Air transportation costs were also lower as were the cost to purchase a new vehicle. The seasonally-adjusted CPI rose 0.1% following the 0.3% decline in June. The seasonally-adjusted core index rose 0.3% in July, reversing June's 0.3% decline.

Relative to a year earlier, the inflation rate eased to 2.7%. Persistent increases in gasoline prices during the year resulted in a 23.5% rise, although this was a slower pace than June's 28.5% increase. Excluding gasoline, the headline inflation rate stood at 1.7%, the slowest pace of increase since February. Food prices were 4.3% higher than a year ago. The pace of clothing and footwear price inflation, inched back up to 1.0% from 0.8% in June. Vehicle prices of were 1.0% lower than in July 2010, although the pace of decline eased from the 3.1% dip recorded in June.

The July Inflation Report confirmed that after a four-month stint of the headline rate running above the upper end of the Bank's target range, price pressures slowed to a 2.7% pace. The implementation of the HST in July 2010 is estimated to have added 0.4 percentage points to the headline rate during the past year with a similar-sized reduction embedded in today's report. We expect the headline rate to drift even lower given the declines in commodity prices that occurred in August. The July inflation data showed energy prices were running 13.0% above the levels a year earlier and food prices were up 4.3%. In August, West Texas Intermediate oil prices fell by 10.5%, suggesting that energy costs will provide less upward pressure on the headline rate going forward. The rebound in the core inflation rate in July, which the Bank uses to monitor underlying inflation pressures, is partially a reflection of overstated weakness in June being reversed and partially a reflection of the HST effect.

The as expected movements in the inflation rates are unlikely to garner much attention by financial markets with all eyes on Finance Minister Flaherty and Bank of Canada Governor Carney's testimony later this morning. Given the shift in market sentiment, surging volatility, and uncertainties regarding the end game for the European sovereign-debt crisis, today's statements are likely to focus attention on renewed downside risks to Canada's economic outlook. Recent data reports, filling in the second quarter of 2011, have disappointed and are consistent with real GDP growth of just 0.2% at an annualized rate in the quarter. To be sure, these activity levels were dampened by one-off factors that hurt auto manufacturers and the output of the oil, gas, and mining industries. A shaky showing in the second quarter and renewed jitters about the ability of Europe to stave off a sovereign debt and/or financial system crisis will be reflected in the tone of today's testimony. Our assessment is that the sharp slowing in the pace of Canadian economic growth will prove temporary as auto production bounces back in the third quarter of 2011 and resource companies come back on line after a combination of natural disasters (e.g., forest fires and flooding) and retooling cut output in the second quarter. The near-term risk to our outlook is the volatility in equity markets that resulted in the TSX losing 6.3% so far this month. If these loses are sustained and/or deepened, then the hit to net wealth and confidence raises the prospect that consumers and businesses will be hesitant about spending until the air clears. Both officials are likely to steer away from suggesting that the global economy is headed back into recession although Mr. Carney may hint that interest rates in Canada, as in other countries, will remain low for a considerable time to mitigate the downside risks.
Source:actionforex