MORTGAGE: Banking on interest cut

The steepest one-month drop in consumer prices in nearly half a century has opened the door to more interest rate cuts from the Bank of Canada to stimulate the depressed economy.

But the one-per-cent drop in prices in October from September reinforced fears of a downward spiral toward deflation -- a period of falling prices that feeds on itself and hasn't been seen in North America since the Great Depression.

Canadians and their struggling economy can bank on another half a percentage point cut in interest rates next month, analysts said in the wake of news Friday of the faster-than-expected retreat in the inflation rate,

"The Bank of Canada has the all-clear signal to continue cutting rates," BMO Capital Markets economist Douglas Porter said after Statistics Canada reported that consumer prices posted their steepest one-month fall since 1959. That in turn knocked the annual inflation rate -- the increase in prices from a year earlier -- down sharply to 2.6 per cent from 3.4 per cent in September.

But the speed of the decline in inflation renewed warnings that Canada was rapidly sliding toward deflation where falling prices would encourage consumers to put off purchases in hope that prices will fall further, which in turn would worsen an already deteriorating economic situation.

"This pace could put Canada on the cusp of deflation, even in annual terms, within three months," said Erin Weir, an economist at United Steelworkers, noting that evidence suggests prices have fallen further this month, and arguing that this adds to the urgency for further rate cuts and added fiscal stimulus from governments to encourage spending.

"Today's news confirms that the Bank of Canada should have cut interest rates more deeply last time," Weir said.

While the central bank has indicated there will likely be further rate cuts, Finance Minister Jim Flaherty has warned there will be no added fiscal stimulus until his budget, expected in February.

Not all analysts agreed that deflation is yet a threat.

"Inflation in Canada is simply not a problem, being low enough for the Bank of Canada to go all out to get the economy moving, but not seriously threatening the much dreaded deflation disease," said Avery Shenfeld, economist at CIBC World Markets.

However, most analysts agreed that the drop in inflation was steep enough to ensure the Bank of Canada cuts its trendsetting target rate for overnight loans by half a percentage point to a historically low 1.75 per cent on Dec. 9, its next scheduled date for any rate change.

That should translate into a cut in the commercial banks' prime rates and in turn into lower borrowing costs for consumers and lower rates on existing loans tied to prime, such as floating rate mortgages, and consumer and business loans.

In Canada, cheaper energy costs last month offset the impact of higher food prices.

But, even the core inflation rate, which strips out volatile food and energy prices and is monitored by the Bank of Canada for inflation pressures, was stable at 1.7 per cent -- less than the 1.9 per cent economists had anticipated. Consumer prices fell 0.5 per cent from September to October, it said.

(prepared by Eric Beauchesne/Vancouver Province)