Is inflation making a comeback?
By Peter Diekmeyer • Bankrate.com

Last week, the Bank of Canada surprised analysts by keeping its policy lending rate steady at three percent. Canada's economy has been showing signs of weakness, and many thought that a rate cut was in order. By signalling that interest rates ought to be lower, the central bank could easily have sparked a new round of borrowing and consumption that would have provided the economy a nice boost. So, why didn't it?

The problem is that the Bank of Canada maintains a steady balancing act between maintaining a smoothly running economy and keeping inflation under control.

That's getting much harder because a wide variety of inflationary pressures have emerged recently. These range from rising fuel and food prices to slowing growth in outsourcing to rising transportation costs and loose monetary policy at many of the world's major central banks. And as bad as these are, things could get worse. Much worse.

Inflation: is a good run coming to an end?
Canadians have had a good run on the inflation front for some time now. Prices for most goods and services we buy have increased only gradually for most of the past quarter-century. Even house prices, which have risen quite quickly over the past eight years, rose far more moderately when looked at over a longer stretch. In other sectors, such as manufacturing imports from emerging nations, prices have even fallen.

As recently as the first quarter of 2008, core inflation in Canada was running at just 1.4 percent in real terms and total inflation was just 1.8 percent. But last week, the Bank of Canada raised its forecast for total Consumer Price Index, or CPI, inflation by later this year to three percent.

According to Jeff Rubin and Benjamin Tal, two economists at CIBC World Markets, one of the reasons that inflation has been kept under control so well in Western countries is that outsourcing by Western manufacturers and rising imports from low-wage countries like China have kept price increases in line.

However, those imports are now being threatened by rising fuel costs. "Higher energy prices are impacting transport costs at an unprecedented rate. So much so, that the cost of moving goods, not the cost of tariffs, is the largest barrier to global trade today," write the two in a recent paper for the bank's clients. "(These) exploding transportation costs are removing the single most important brake on inflation over the last decade -- wage arbitrage with China."