By Louise Egan
OTTAWA (Reuters) - Canada's inflation rate slowed in February but, unexpectedly, stayed within the central bank's comfort zone, news that may reassure policymakers but is unlikely to trigger a change in the bank's neutral stance on interest rates.
Statistics Canada also released figures on Friday that showed retail sales regained some ground in January after taking a big hit in December due to extreme winter weather. Sales in increased by 1.3 percent in January, the fastest pace since May.
Both reports signaled the economy moved to a stronger footing in early 2014 after a soft patch in December.
"Good news on both fronts," said Benjamin Tal, senior economist at CIBC World Markets. "The retail sales was better than expected, defying expectations for a softer consumer. But even more important was the CPI (consumer price index)."
Consumer prices rose 1.1 percent in the year to February, down from a 1-1/2 year high of 1.5 percent in January but above the market forecast for a 0.9 percent increase. Lower gasoline prices partially offset higher shelter and food costs in February, it said.
Core inflation, a gauge of underlying price trends, was also a notch above expectations at 1.2 percent, but down from 1.4 percent in January.
Chronically weak inflation is the Bank of Canada's biggest headache at the moment because it often means a stagnant economy, and it is the reason the bank dropped a policy bias toward raising interest rates last year. The bank aims to keep inflation at 2 percent, within a range of 1 percent to 3 percent. The inflation rate has been below 2 percent for 22 months.
The latest data may put to rest any lingering speculation that the bank will cut rates this year, said Paul Ferley, assistant chief economist at Royal Bank of Canada.
"Inflation is still low, but at least we've moved into the target range," he said. "So that will probably ease some of that discussions of the need for the Bank of Canada to maybe introduce some rate cuts, and with that it should provide a bit of support for the Canadian dollar."
Bank of Canada Governor Stephen Poloz said on Tuesday he expected lower February inflation because the comparison rate in February 2013 showed a sharp pickup in prices.
"Looking through the short-term volatility, inflation still seems to be running at around 1.2 percent, give or take a tenth or two," he said.
The bank also believes there is some "good disinflation" in the mix, caused by a more competitive retail sector with the expansion of big discount stores such as Walmart and Target in Canada. That trend is good for consumers and is less of a worry, it says.
Analysts surveyed by Reuters expect the central bank to hold its main overnight rate at 1.0 percent until the third quarter of 2015, but traders have been pricing in a small chance of a rate cut later this year. Those bets were scaled back after the inflation data was released.
The Canadian dollar firmed immediately after the data, trading at C$1.1179 to the greenback, or 89.45 U.S. cents. It later softened to 89.31 U.S. cents.
WEAK FIRST QUARTER
The strong retail sales in January, which included a 1.4 percent jump in the volume of sales, suggest gross domestic product (GDP) is set to retrace a 0.5 percent decline in December, said Nathan Janzen, economist at RBC Economics.
But GDP growth in the first quarter still looks much weaker than it was in the fourth, at about 1.2 percent, annualized versus 2.9 percent in the last quarter of 2013.
"A further easing in weather-related December weakness bodes well for activity to continue to improve going forward," Janzen said.
The retail sales report showed consumers are still the main force behind economic growth in Canada despite calls from the central bank for businesses and exporters to assume a greater role in driving growth because households are already highly indebted.
In January, six retail subsectors rebounded from lower sales in December, led by motor vehicle and parts dealers and building material and garden equipment supplies stores.
As with the inflation report, the retail sales figures may not substantially change the central bank's prevailing outlook for sluggish economic growth, however.
"It's a good number, but that number alone is not going to deter their broader view on the economy," said Andrew Kelvin, strategist at TD Securities.
(Additional reporting by Alex Paterson, Solarina Ho, Andrea Hopkins and Allison Martell; Editing by Steve Orlofsky; and Peter Galloway)