REPEAT: MNI BOC ANALYSIS: Oil, Firm Infl Seal Tightening Case

Repeats Story Initially Transmitted at 17:39 GMT May 18/13:39 EST May 18

--But No NAFTA Deal Leaves Uncertainty Hanging

By Yali N'Diaye

     OTTAWA (MNI) - Rising oil prices, firmer inflation and even

stronger-than-expected retail sales are sealing the case for more tightening,

but key reasons for the Bank of Canada's caution remain, making it unlikely for

the central bank to accelerate the normalization process and move as soon as May

30.

     Statistics Canada reported Friday that headline inflation ticked down to

2.2% in April from 2.3% in March, but remained above the BOC's mid-range 2%

target for the third consecutive month. Prices were up 0.3% from the previous

month.

     Once again, gasoline prices explained much of the increase, as prices

excluding gasoline rose 0.2% on the month and 1.8% year-over-year.

     In addition, the BOC has already factored in an acceleration of inflation

in the second quarter to 2.3% from 2.1% in the first quarter, so April's 2.2%

reading should not move the needle.

--CORE INFLATION FIRMS

     Still, even if gasoline explained much of April's price gains, the BOC's

three preferred measures of core inflation firmed, indicating that with the

economy operating close to capacity, forces other than energy were definitely at

play.

     The range of preferred measures inched up to 1.9%-2.1% in April from

1.9%-2.0% in March, confirming a trend that has become increasingly apparent

over the recent months.

     Such trend should further increase the central bank's confidence in the

need to continue to tighten its policy.

--OIL PRICES

     In its April Monetary Policy Report, the BOC said oil prices and minimum

wage hikes are expected to put upward pressure on prices.

     In fact, in April, food purchased from restaurants were the second largest

contributor to year-over-year inflation after gasoline, and this is one category

where minimum wage hikes should be particularly felt.

     That being said, several analysts see no reason for oil prices to come back

down.

     The BOC does not forecast oil prices but uses the recent average to compile

its growth forecasts. The April 18 estimates assumed the Brent at USD65 per

barrel and the West Texas Intermediate at USD60, about the same as assumed in

the January MPR.

     On Friday, the Brent was around USD78.2 per barrel and the WTI at USD71.3,

up from USD 73.9 and USD 68.5, respectively, on April 18, and after starting the

year around USD 66.7 and USD 60.0.

     Should oil prices continue to appreciate, the BOC might reassess how it

could impact investment in the energy sector, which represents 20% of business

investment in Canada. In April, it estimated that overall business investment

would continue to recover, but that it would decline in the energy sector this

year due to reduced competitiveness.

     For Capital Economics, "prices are probably still too low to trigger a

renewed investment boom in the Canadian oil sands because of the relatively high

breakeven costs of production."

--THE NAFTA DRAG

     With current developments around Iran continuing to spur concern over oil

supply, the BOC will likely want to take some time to analyze the sustainability

of higher oil prices and how it affects prospects for Canada's growth and

inflation. Perhaps the "transitory" effect of higher gasoline prices on

inflation might become more sustained than it had anticipated. 

     While rising oil prices and firmer inflation add to the positive side of

the balance of risks, NAFTA-related uncertainty is still hanging, especially

after a procedural deadline for a resolution passed Thursday, accompanied by

contradicting comments from Canadian and U.S. officials on the prospects for a

quick deal.

     The failure to meet such deadline exposed still unresolved issues and left

uncertainty for businesses intact, which should keep the BOC on the cautious

track.

     --STILL HOUSING ISSUES

     In addition, the central bank is still likely to continue to take some more

time to assess the impact of higher interest rates on the housing sector and the

overall economy.

     It has given no indication that it would have a clearer picture on the

exact reasons behind the housing slowdown before the summer.

     Meanwhile, while the latest data on consumer spending surprised on the

upside Friday, the underlying picture showed such spending is in fact slowing.

     Retail sales rose 0.6% in March, with volumes up 0.8%, more than analysts

had expected.

     If not for a 3.0% increase in autos and parts, however, sales would

actually have contracted by 0.2%.

     For the first quarter as a whole, real retail sales fell 1.0%, erasing the

1.0% gain in the fourth quarter.

     The BOC is expecting household spending contribution to growth to decrease,

so such an outcome was not that surprising.

     However, as this part of the growth rotation scenario materializes, the

business investment part continues to face uncertainty, while housing

developments need more clarity.

     Against this backdrop, the central bank will likely prefer to wait until it

gets a better gauge of the impact of its tightening since last summer rather

than risking derailing growth.

     As a result, while Friday's inflation data and better-than-expected retail

sales headline sealed the case for more tightening, they did not call for an

acceleration, leaving July as the most likely next rate hike.

--MNI Ottawa Bureau; +1 613 869-0916; email: yali.ndiaye@marketnews.com