Canadian inflation was unexpectedly high in July despite a cut in the federal sales tax, though the Bank of Canada's core inflation rate remained on target, making a near-term change in interest rates unlikely.
Annual inflation was 2.4 percent in July, down from 2.5 percent in June, but well above the 2.0 percent that analysts had expected, data from Statistics Canada showed on Tuesday.
Statscan said gas stations and fruit vendors had jacked up prices, so that a one-percentage-point cut in the goods and services tax (GST) rate to 6 percent beginning July 1 had less of an impact on overall inflation than expected. The consumer price index (CPI) rose 0.1 percent on the month even though economists had expected a decline of 0.3 percent.
"This suggests that price increase pressures were important enough in July to more than compensate for the expected effect of the 1.0 percent reduction in the GST," Statscan said.
Cutting the sales tax was the cornerstone of the inaugural budget in May of the minority Conservative government, which also promised to further reduce the unpopular tax to 5 percent in the future.
The report sparked a rally in the Canadian dollar, which at 10 am (1400 GMT) rose to C$1.1158 to the US dollar, or 89.62 US cents, from a pre-data level of about C$1.1191 to the US dollar, or 89.36 US cents. Statscan's measure of core inflation, which excludes eight volatile items, met expectations at 1.5 percent on the year, while core prices dropped 0.2 percent on the month.
The Bank of Canada examines the effect of tax changes in its measure of core inflation, which is key to setting monetary policy. The central bank's core rate was 2.0 percent on the year, at the center of its target range, up from 1.7 percent in the year to June.
"We look for core inflation to just hang around the 2 percent mark in the next few months, as does the Bank, keeping policy makers on the sidelines during the second half of 2006," said Doug Porter, deputy chief economist at BMO Capital Markets.
The Bank of Canada has kept its key overnight interest rate on hold at 4.25 percent since May following seven consecutive hikes, saying it expected the economy to gear down somewhat in the second half of this year.
Most economists rule out any further interest rate hikes this year. Indeed, some are betting on a rate cut by early next year amid recent sluggish economic signals.
"Weaker-activity statistics will make the Bank of Canada very comfortable staying on hold, but there is certainly nothing in these inflation numbers that would suggest a rate cut is in order very soon unless we get clearer signs that second-half growth will be significantly below trend," said Mark Chandler, senior market economist at Scotia Capital.
Statistics Canada had expected the cut in the GST in July to shave 0.6 percentage points off the inflation rate for one year, assuming the full benefit of the change was transferred to consumers. That calculation didn't take into account an increase in excise duties on alcohol and tobacco which also took effect in July.
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