Canada's annual inflation rate slid to the lowest level in 56 years last month, dropping more than expected for the second straight month to set overall prices 0.9 per cent lower than last year, Statistics Canada reported Wednesday.

The fall on a month-to-month basis was even more dramatic, as prices in July fell 0.3 per cent from the previous month, reversing the similar monthly increase registered in June.

Still, economists say there is little concern that deflation - a broadbased and persistent decline in prices that could inflict further damage on the economy - is setting in in Canada, as it did in Japan during the 1990s.

That's because only three of the major components tracked by Statistics Canada are experiencing deflation and most of that is based on falling gasoline prices.

In July, consumers paid 4.1 per cent less at the pump than they did the previous month, and 28.3 per cent less than they did last July.

"Regular unleaded gasoline prices at self-service stations averaged 97.4 cents per litre in July 2009 compared with a record high of just under $1.37 in July 2008," the agency noted.

But analysts expect the impact of gas prices on inflation is due to reverse next month, which could cause the current deflationary trend to reverse course. The influence of gas prices has mirrored the downward spiral in oil prices, which peaked at US$147 a barrel last July before plunging over the following year.

"We don't have a deflation or an inflation problem in Canada," said Meny Grauman, an economist with CIBC World Markets.

Statistics Canada also pointed out that excluding the energy component, inflation remains a healthy 1.8 per cent in Canada. Core inflation is also close to where the Bank of Canada would like it, at 1.8 per cent, only slightly below the desired two-per-cent target.

Scotiabank economist Adrienne Warren predicted the July number will be the low point of the cycle and that annual inflation will return to positive territory in October.

Although most consumers would welcome widespread price decreases, economists say a prolonged deflationary cycle could have the effect of further undermining activity if consumers and businesses decide to hold off spending in hopes of realizing bigger savings in the future.

Still, Canadians were seeing many bargains when they went shopping last month.

Besides lower pump prices, the cost of purchasing a car was 4.3 per cent lower than last year, shelter prices fell two per cent, mortgage interest costs were 0.1 per cent lower, and clothing and footwear cost 2.1 per cent less than last July.

The key contributor to inflationary pressure continued to be food prices, which were five per cent higher in July on an annual basis.

But Warren noted the year-long strong buildup of food prices also appears to be slowing and will likely result in inflationary pressures being kept in check even after the impact of gas prices has worn off.

Food prices had risen 5.5 per cent in June, and 6.4 per cent in May.

"There is some evidence now that there's a market share price competition among the major grocery store chains, and consumers are a little more price conscious," she said.

As well, car insurance rose 5.1 per cent last month, tempering the overall descent in the gas-price dominated transportation component.

Regionally, eight provinces experienced negative inflation last month, with British Columbia heading the pack with a minus 1.6-per cent reading.

Saskatchewan was the only province with positive inflation, at 0.9 per cent, while prices were flat in Manitoba.

The Bank of Canada offered a rosier, revised outlook on the economy Tuesday.

It now believes the economy is beginning to recover from recession and will perform better than expected in the next 18 months.

The central bank maintained its key overnight rate at the lowest possible level of 0.25 per cent, and committed to keep the rate there until the spring of 2010.

The revised outlook sees less shrinkage and more growth in the economy, according to Michael Kane of BNN.

"The bank of Canada now says the contraction will not be quite as bad as expected, and the expansion greater than expected," Kane told CTV News Channel.

"Previously it was expected that the Canadian economy would contract by 3 per cent this year, and then grow 2.5 per cent next year. They are moderating all those numbers now, and the latest expectation is for a smaller 2.3 per cent contraction this year, a slightly larger 3 per cent growth next year," Kane said.

Kane noted that measures taken by the bank and the federal government to help the economy from slipping too much -- such as stimulus funding and lower interest rates -- appear to be working.

The bank also said credit conditions have improved so much it is reducing the amount of money it is injecting into the system to support lending.

TD Canada Trust (TSX:TD) has lowered its residential mortgage rates between 0.1 and 0.6 percentage points, bringing the signpost five-year closed mortgage rate down 0.2 points to 5.25 per cent.

Among the changes to the bank's posted rates, a one-year open rate fell 0.15 points to 6.55 per cent, a three-year closed mortgage was reduced 0.75 to 4.15 per cent and the seven-year closed rate dropped 0.1 to 6.6 per cent.

The 10-year closed rate was unchanged at 6.7 per cent.

The moves brought TD rates roughly in line with those of Bank of Montreal (TSX:BMO) and Royal Bank (TSX:RY), both of whom lowered fixed rates last week on the heels of a Bank of Canada overnight rate cut.

Royal and BMO's five-year closed rates were also dropped 0.2 points to 5.25 per cent.

Last Tuesday the central bank took the overnight target rate to 0.25 per cent, the lowest level practical and committed to keep it there for a year.

The commercial banks quickly cut their prime lending rates in step with the Bank of Canada, moving the benchmark for variable-rate mortgages and other loans by a quarter-point to 2.25 per cent.

At the same time

Scotiabank (TSX:BNS) lowered its rates by between 0.3 and 0.2 per cent. Its five-year closed mortgage rate is now also 5.25 per cent.

Laurentian Bank (TSX:LB) dropped its rates by between 0.25 and 0.4 per cent. Its five-year closed rate is also 5.25 per cent, a drop of 0.2 per cent.

The world needs a new way to supervise and regulate financial systems to restore stability and might want to follow Canada's example, the governor of the Bank of Canada said yesterday.

In a lecture to the University of Alberta's school of business, Mark Carney said Canada has weathered the financial storm better than most.

"Our system is better,'' Carney said. "Regulation has been more consistent. Our banks have been more conservative.

"Credit conditions in Canada remain superior to those in virtually every other industrialized country," he said.

"Canada is in a good position to offer sound advice as leaders of the G20 prepare for this week's summit in London. The core of our system has many -- although not all -- of the elements of a more sustainable, global financial system.''

Carney said that all financial activities that can pose a major risk to stability should be regulated.

However, he disagreed with the idea that banks should be tightly restricted to their core functions -- taking deposits and making loans -- and kept away from financial markets.

"To this way of thinking, banks could not then get themselves into trouble, or if they did, their demise could be safely managed," Carney said.

"But this is impractical, because banks and their roles are vital to the existence of markets. They are agents and underwriters and traders of most government and corporate debt.

"They provide cross-border financing products which are key services in a world of global corporations."

The better solution, he said, is to expand the perimeter of regulation to better supervise more players.

Carney placed much of the blame for the present financial crisis on the rise of a so-called shadow banking system, which appeared in recent years and usurped many of the functions normally provided by banks.

Canadian Mortgage brokers, finance companies, hedge funds, structured investment vehicles and the like grew enormously, but were performing without a safety net. The shadow system was wholly reliant on the continuous availability of funding markets.

As liquidity began to dry up last August, the whole structure tottered.

"The regulatory system neither appreciated the scale of this activity, nor adequately adapted to the new risks created by it," he said. "The shadow banking system was not supported, regulated or monitored in the same fashion as the banking system. With hindsight, the shift toward the shadow banking system that emerged in other countries was allowed to go too far for too long."

"It's time to regulate this system and this week's G20 meeting will have to start that process,'' he said.

"Canada will contribute an important perspective on these issues."

The Bank of Canada has cut a key short-term interest rate about as low as it can go in what is becoming a frantic effort to spark recovery from a recession it admits it has misjudged.

The central bank did what virtually every private sector economist advised it to do Tuesday morning, slashing the trend-setting overnight rate to 0.5 per cent into uncharted territory.

But bank governor Mark Carney, who was criticized for being overly rosy in his January economic outlook, now says that even at such unheard-of lows, the stimulus provided by traditional monetary policy is likely not enough.

And he said the bank now sees recovery coming later than it had projected, possibly in early 2010.

‘‘Given the low level of the target for the overnight rate, the bank is refining the approach it would take to provide additional monetary stimulus, if required, through credit and quantitative easing,’’ Carney wrote in a statement.

The central banker does not give examples of specific measures, but BMO deputy chief economist Doug Porter said the bank is considering a process whereby it injects money into the system buy buying up assets such as government bonds, asset-backed commercial paper and even government bonds directly.

‘‘Simply put, the bank is preparing to pull out all the stops to support the economy,’’ he said.

Canada’s major banks appeared ready to play ball with Carney: shortly after the announcement, Royal Bank (TSX:RY), Bank of Montreal (TSX:BMO), TD Bank (TSX:TD) and CIBC (TSX:CM) announced that they would cut their prime rates in step with the central bank.

The reference to non-traditional monetary measures confirms that Carney knows he has exhausted interest rate cuts as a means of stimulating the economy out of a deepening and increasingly stubborn recession.

Darcy Briggs of Bissell Investment Management in Calgary said the bank could trim rates to 0.25 per cent — as the U.S. Federal Reserve has done — but ‘‘practically, what would that do?’’

As former Liberal cabinet minister and economist Doug Peters wrote last week: ‘‘Interest rates that count, such as interbank lending rates, mortgage lending rates, bank commercial lending rates, are all unusually high, especially considering that inflation is also very close to zero.’’

The other surprise was that Carney appeared to back off his relatively rosy forecast for the Canadian economy, which envisioned growth returning in the third quarter of this year and rebounding to 3.8 per cent next year.

‘‘The outlook for the global economy has continued to deteriorate since the bank’s January... update, with weaker-than-expected activity in major economies,’’ Carney said Tuesday.

‘‘National accounts data for the fourth quarter of 2008 and other indicators of aggregate demand point to a sharper decline in Canadian economic activity and a larger output gap through the first half of 2009 than projected in January.’’

Carney said potential delays in stabilizing the global financial system, along with low consumer confidence and larger hit on household wealth, ‘‘could mean that the output gap will not begin to close until early 2010.’’

Tuesday’s statement does not officially alter the forecast, but strongly implies that both this year’s 1.2 per cent contraction will be worse and that the recession may last until next year.

Most economic indicators have come in far weaker since January’s much-criticized bank outlook, including Monday’s report that the Canadian economy has shrunk by 3.4 per cent in the last quarter of 2008, far worse than the bank’s negative 2.3 per cent projections.

As well, Canada lost 129,000 jobs in January, a massive amount, which Carney did not know when he made his forecast.

But possibly the most critical factor is that the global economy, especially among industrialized nations, appears to be in free-fall.

The fourth quarter saw GDP fall by 6.2 per cent in the United States, six per cent in the United Kingdom, 5.7 per cent in the Eurozone, 10.3 per cent in Mexico and a massive 12.7 per cent in Japan.

And far from stabilizing, the U.S. financial system is lurching from crisis to crisis. On Monday, the U.S. government said it was adding another $30 billion to the bail-out package for the giant insurance company American International Group Inc. after it reported a staggering US$61.7-billion in quarterly losses.

‘‘Stabilization of the global financial system remains a precondition for the global and Canadian economic recoveries,’’ Carney noted in his statement.

Carney also forecast that inflation will likely be lower than expected this year.

The Bank of Canada should cut interest rates to a record low next week to stimulate the economy, a panel of private-sector economists said Thursday as evidence of a deepening recession - globally and in Canada - mounted, including a major drop in Canadian home sales and home prices.

The C.D. Howe Institute panel called for a further half-point cut next Tuesday in the bank's trendsetting target rate to one per cent. One of the 10 members called for a full-point reduction, and another for a whopping 1.25-point drop to just 0.25 per cen

The half-point recommended by the panel would likely trigger a matching cut in the chartered banks' blue-chip prime rate - to which business and consumer floating-rate loans, including mortgages, are tied - to three per cent from an already all-time low of 3.5 per cent.

The need for further housing-market stimulus was highlighted by the Canadian Real Estate Association, which reported that home sales in December fell 1.8 per cent from November to their lowest level since 2000.

And the average price of a home plunged 11 per cent from a year earlier in December, and was down for the year as a whole, ending the nine-year housing boom of steady price gains.

"Average prices will remain under pressure during the Canadian economic recession," warned association chief economist Gregory Klump.

"There has been a fundamental shift in consumer confidence, with job insecurities prevailing in every region Canada. That is unlikely to change until the worst of the recession is behind us."

The industry association appealed to the federal government to include measures in its Jan. 27 budget to stimulate housing, including an increase from $20,000 to $25,000 in the amount homebuyers can draw tax-free out of their RRSPs for a down payment, and expanding the provision to include more than just first-time home purchasers.

However, association president Calvin Lindberg cautioned that "moderating home prices in Canada should not be confused with the downturn in the U.S. housing market" that pushed that giant economy, and in turn the global and Canadian economy, into recession.

The U.S. recession is still deepening, reports Thursday suggested.

"Consumer sentiment reached a six-year low as Americans continued to be rocked by increasing job losses, poor holiday-shopping season reports, and the ongoing inability of the government and the private sector to stabilize the economy," RBC said in a report based on a survey of U.S. consumer attitudes and spending.

Considering the U.S. consumer accounts for 70 per cent of that economy's GDP, and the U.S. accounts for 75 per cent of Canadian exports, that doesn't bode well for Canadians either.

Still, there was a hint of hope amid the rubble of the RBC survey's findings - a marginal increase from 29 per cent to 30 per cent of respondents who expect their local economy will be stronger in six months' time.

The analysis said this may reflect an enthusiasm for soon-to-be-inaugurated U.S. president-elect Barack Obama and "Americans' openness to the stimulus proposals coming out of Washington rather than any expectation that local economies will improve quickly."

In light of the deepening slump in the U.S. economy and consumer confidence, it's not surprising the mood of Canadian exporters has also hit an all-time low.

But it was concerns about domestic sales prospects that weighed most heavily on exporters, Export Development Canada chief economist Peter Hall said Thursday in releasing results of the fall survey on the confidence of exporters.

Just 28 per cent - the lowest share ever by a wide margin - expected a near-term increase in domestic sales, while only 12 per cent expected an improvement in the domestic economy, while a record high 57 per cent expected a further deterioration.

"Over the past five years, exporters were able to count on a strong domestic market to tide them through the relentless rise in the Canadian dollar," Hall said.

"Last fall, that upbeat view of the domestic scene soured considerably."

Underscoring their pessimism about the domestic economy was news from Statistics Canada of a further seven per cent drop in new car sales in November, the steepest monthly plunge in three years.

Meanwhile, showing the growing global concern about the economic crisis was a decision by the anti-inflation-focused European Central Bank to cut its trendsetting interest rate to two per cent.