MONTREAL - Air Canada will continue its attempt to raise fares and trim costs where possible in the coming months as it tries to absorb elevated fuel costs that threaten future profitability.

"High fuel costs and volatility clearly remains the single largest challenge facing our industry," president and CEO Calin Rovinescu said Thursday during a conference call.

Fuel costs surged by 40 per cent from a year ago and are expected to add about $800 million to the airline's operating expenses this year.

"To mitigate the impact of this fuel cost increase, we're looking at adding additional cost reduction opportunities beyond those identified through our cost transformation program and, where competitively feasible, we have increased fares and introduced fuel surcharges," he told analysts.

Air Canada and rival WestJet (TSX:WJA) have implemented price increases to offset the higher costs and take advantage of improved consumer confidence in Canada.

The Montreal-based carrier narrowed its losses to $46 million in the second quarter as the country's biggest airline improved operating earnings on the back of higher revenues and reduced non-fuel costs.

Air Canada (TSX:AC.B) reported a loss per diluted share of 17 cents for the three months, compared with a net loss of $318 million, or 20 cents per share, in the same period last year.

On an adjusted basis, the loss was 20 cents per share, falling in line with average expectations from analysts polled by Thomson Reuters.

Operating income was up 55 per cent to $73 million in the quarter compared with $47 million in the second quarter of 2010.

Passenger revenues increased $272 million or 11.7 per cent to $2.9 billion on a 6.1 per cent growth in traffic and a 5.2 per cent improvement in yield.

Premium business class revenues grew $54 million, or almost 11 per cent, from the same quarter in 2010 due to traffic growth of 13 per cent.

"We're pleased to have delivered a solid financial performance in the quarter, which underscores the progress we are making delivering on our corporate priorities," Rovinescu added.

Cameron Doerksen of National Bank Financial said Air Canada's second-quarter results were generally ahead of forecasts.

Unit costs were better than expected, he said, as non-fuel expenses decreased 3.7 per cent as it achieved $475 million of its $530 million in annualized savings for the year.

Air Canada also reported that its traffic increased by 4.3 per cent in July amid a 2.5 per cent increase in capacity. Planes flew a record 86.4 per cent full in the month.

Despite ominous signs of an economic slowdown in the United States, Air Canada assumes the Canadian economy will continue to grow this year.

"If we do see a downturn, we are certainly prepared to adjust capacity and take whatever actions...if the markets do change," said chief financial officer Michael Rousseau.

But Walter Spracklin of RBC Capital Markets trimmed his share price target to $2 from $2.50 on Thursday over concerns about oil prices and the economy.

He said Air Canada enjoyed a "surprisingly strong quarter" as a strong Canadian dollar reduced costs and demand remained resilient as passengers absorbed higher fares.

"(But) something's gotta give," he wrote in a report.

"While we are impressed with the traffic levels and yields, the emerging severity of the economic signals to date begs the question as to how long traffic and rates will remain robust."

The airline and its regional partners, including Chorus Aviation Inc. (TSX:CHR.B), carry about 31 million passengers annually to more than 170 destinations on five continents.

On Monday, Air Canada announced a tentative contract with flight attendants to avert the possibility of a second strike this year. A three-day walkout by customer service and airport workers ended after the federal government threatened back-to-work legislation.

Air Canada's shares closed down 10 cents, or 4.74 per cent, to $2.01 in trading Thursday on the Toronto Stock Exchange.