Why Carney will shrug off the uptick in prices

Higher prices for necessities like gasoline and food are increasingly biting into family budgets, as wages in much of the country fail to keep up with the cost of living.

This long-running story continued in January, according to Statistics Canada data released Friday. Gas prices were 6.8 per cent higher than a year earlier, bread was almost 10 per cent more expensive, vegetable prices were more than 8 per cent higher and meat prices rose by 6.5 per cent. Oh, and electricity was more than 7 per cent more expensive.

All told, the consumer price index was 2.5 per cent higher than in January, 2011, a faster gain than December's 2.3 per cent increase. Even the annual core rate, which excludes energy and many foods, accelerated to 2.1 per cent from 1.9 per cent. In fact, virtually all categories posted increases in January.

Still, will the Bank of Canada to be swayed by any of this?

Almost certainly not, other than to move further away from thinking about cutting interest rates to boost the economy. (Which, given Governor Mark Carney's escalating concerns about the link between low-for-long borrowing costs and dangerous levels of household debt, has been off the table for a while and probably was never a very realistic possibility.)

Policy makers have all but said they will ignore anything but the hottest inflation data until the European debt crisis is closer to a lasting resolution and no longer a clear and present threat to the global recovery. Indeed, Mr. Carney took great care last fall to condition the public and markets for a long extension of his already very long interest-rate pause, by arguing that his mandate to keep inflation advancing at an annual rate of 2 per cent does not require him to reach that goal in a set time frame if the economy is shaky.

Also, the increase in core inflation was largely because of deep December discounts in the auto industry being reversed in January, so a one-off increase. As for total inflation, high energy prices meant that the average year-over-year gain in 2011 was 2.9 per cent, one tick shy of the upper limit of the central bank's comfort zone, and the fastest pace since inflation-targeting in Canada began two decades ago. But Mr. Carney's latest forecasts in mid-January indicate that in the second quarter of this year, inflation will slow to 1.5 per cent as headwinds from abroad keep the domestic economy operating at less than full tilt.

And even though Mr. Carney and his officials like to say that they do not outsource Canadian monetary policy to the U.S. Federal Reserve, there is a limit to how much the Bank of Canada can tighten borrowing costs before the Fed does. Ben Bernanke and his policy committee have not only signalled they intend to keep rates at rock-bottom levels until late 2014, they also appear skeptical of a recent spate of positive economic reports in the U.S., citing the global slowdown in demand. Even though a report in Washington today indicated that U.S. inflationary pressure is spreading again, Mr. Bernanke has also indicated he will tolerate sticky inflation readings until the labour market is on more solid footing.

That means a third, multi-billion-dollar purchase of financial assets cannot be ruled out, and if that occurred it would be even tougher for the Bank of Canada to raise rates here, since it would put upward pressure on the Canadian dollar, making like that much harder for exporters.

There's a wild card in all this: Iran.

As tensions mount in the Persian Gulf, it's entirely possible gasoline prices in North America would spike again, as they did at various points of last year's Arab Spring. As it is, Canadian gas prices in January were the highest since August, 2008, notes economist Matthieu Arseneau of National Bank Financial in Montreal. But even steadily increasing gas prices may not shift the overall inflation or interest-rate story much. The more gas prices soar, the less money debt-strapped households have to spend on other items, so prices for other items can only go up so much at the same time. They might even start trending down, if companies find their customers are increasingly unable to afford so-called discretionary purchases. In any case, central bankers on both sides of the border have made it clear that propping up growth is still the No. 1 priority.