Canada’s inflation advantage over the U.S. will continue to allow the Bank of Canada to steer a lower course on interest rates, according to a new study by CIBC World Markets.

“Canada’s inflation rate is nearly 2% below the pace stateside and the strong loonie has to be given credit for that difference,” says Avery Shenfeld, senior economist, CIBC World Markets.

The CIBC World Markets analysis found that it takes up to two years for an appreciation in the Canadian dollar to show up in the inflation gap between Canada and the U.S. “Initially, national prices that are set to what the market will bear, or tied to fixed contracts, prevent the loonie’s new buying power from translating into savings at the retail shelf. But competition, including that from on-line or cross-border outlets, eventually sees the Canadian dollar’s appreciation show up in cooler inflation than in the U.S.,” says Shenfeld.

The study also found that a 10% appreciation in the Canadian dollar lowers Canada’s goods price inflation rate by a half a percentage point relative to the U.S., two years hence. “Even if the Canadian dollar levels off in 2007, it will still be much stronger than the 79 to 86 cent US range it traded at in 2005, so Canada’s inflation rate will still be held in check.”

The strong Canadian dollar has been an albatross around the neck of exporters. But Shenfeld notes that it’s also been key to allowing the Bank of Canada to be ahead of the U.S. Federal Reserve in ceasing interest rate hikes, and at a lower absolute rate.

“Don’t be surprised if the Bank of Canada outguns the Fed in cutting interest rates in 2007, as a tamer Consumer Price Index on this side of the border makes it an easier decision to give the economy the benefit of the doubt,” adds Shenfeld.