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Deflation a concern in North America

 

By Paul Vieira, Financial Post

February 20, 2009

 

OTTAWA -- Inflation in North America is to remain benign for the months -- and perhaps years -- ahead, analysts say, as a shrinking global economy undercuts commodity prices and inventories in Canada remain at excess levels.

 

Data were released in both Canada and the United States on Friday. The Canadian numbers, Bay Street economists say, further strengthen the case for the Bank of Canada to cut its key lending rate by a further 50 basis points on March 3.

 

Further, the data indicate deflation remains a concern for policy-makers on both sides of the border.

 

Statistics Canada said the headline inflation rate dropped for a fourth consecutive month, to 1.1% from 1.2%. The Bank of Canada’s core rate, which removes elements subject to volatile prices, such as energy, dropped to 1.9% from 2.4%.

 

That is in contrast to the United States, where the cost of living rose 0.3% in January, the first climb in six months based on stronger energy prices. Last month, prices fell 0.8%.

 

The U.S. numbers initially eased deflationary fears. Analysts, however, were not so confident. "The near-term risk has lightened a little bit, but if anything the medium-term risk may have been ramped up a notch or two by the clear evidence about how the global economy is sliding," Douglas Porter, deputy chief economist at BMO Capital Markets, said. "The deep dive in the global economy threatens to further undercut commodity prices, and more broadly, pricing power in other industrial goods."

 

Mr. Porter said the BMO economics team envisages the global economy shrinking 0.5% this year. As it happens, economists at Toronto-Dominion Bank issued an updated outlook that forecasts a similar contraction in the world economy -- the first since the Second World War.

 

"Deflation is not a paramount risk right now -- but it is a risk when you are looking at a global contraction," said Richard Kelly, the TD senior economist who issued the revised global forecast.

 

The Bank of Canada had forecast inflation would dip below zero for two quarters this year, largely based on the big drop in energy prices. However, the central bank has dismissed concerns about deflation, calling risk "remote." Mr. Porter said he believes Canada can avoid deflation, "but my conviction is weakening given just how weak the global economy has become."

 

In a related report, David Wolf, chief Canadian economist at Bank of America Securities-Merrill Lynch, said inventory held by Canadian companies remains at higher levels compared with their U.S. counterparts. As a result, this excess supply will attract lower prices -- which will further drive down inflation.

 

Mr. Wolf added there remains an "excess" overbuilding of housing supply in Canada.

 

"That will continue to be a factor that will put a lot of downward pressure on prices," he said, adding that new house prices make up a small component of the consumer price index.

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