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May inflation jump pressures Bank of Canada

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Canadian inflation rose to its highest level in more than eight years in May, boosting the Canadian dollar and raising the prospect the central bank will raise interest rates soon than previously expected.

Annual inflation hit 3.7 percent, well above expectations and far above the Bank of Canada's 2.0 percent target, Statistics Canada said on Wednesday. Gasoline was the lead factor.

The month-on-month rise in prices more than doubled to 0.7 percent from 0.3 percent in April. Analysts expected a monthly rate gain of 0.2 percent, and saw the annual rate holding steady at 3.3 percent. The April rate was 3.3 percent.

"This report will get markets thinking about a move by the Bank of Canada sooner than they had previously anticipated," said Craig Alexander, chief economist with Toronto-Dominion Bank.

"Quite frankly, I think the BoC is still focused on the economic risks. As a consequence, today's inflation report doesn't change our thinking the Bank of Canada probably won't move off the sidelines until January of next year."

Gasoline rose 2.0 percent from April and was 29.5 percent higher than May 2010. Excluding gasoline, the consumer price index was still 2.4 percent higher in May. Other factors in the monthly rise were car insurance premiums, hotels and fresh fruit.

Scotia Capital economist Derek Holt pointed out that the seasonally adjusted monthly rise was only 0.2 percent.

"Controlling for the seasonal adjustments and the clothing component (which rose 2.0 percent on a seasonally adjusted basis), I don't see much of a fanning out of inflationary pressures here," he said.

The Canadian dollar rose to a session high $1.0280 US, shortly after the data, from $1.0238 immediately before.

The rise in inflation boosted speculation by some market players the Bank of Canada could move more quickly to resume the rate hike campaign it started last year. Higher interest rates often support a country's currency because they help attract international capital flows.

Overnight index swaps, which trade based on expectations for the key central bank rate, showed that traders priced in an increased probability of rate hikes later this year, though a full quarter-point rate hike was not priced in until 2012.

The Bank of Canada has said inflation "in the short term" would be above 3 percent—it has a target rate of 1 percent to 3 percent—before returning to 2 percent by mid-2012.

Its core measure, which excludes volatile items such as gasoline, fruit and vegetables, rose to 1.8 percent from 1.6 percent in April. It was forecast at 1.6 percent by analysts for May.

One technical factor in May's increases was a switch to a new consumption basket, based in 2009, from the old 2005 basket. Using the old basket, monthly inflation would have been 0.6 percent and annual would have been 3.6 percent, a Statistics Canada analyst said.

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