Broadening Disinflation Challenges Bank of Canada Narrative

  • Analysis of CPI components shows weakest dispersion since 2013
  • Inflation slowed to 18 month low in June; core rates higher

Feeble Inflation Underpins Bank of Canada Hike Conundrum

Growth may be broadening in Canada, but price pressures are a completely different story.

Inflation slowed to 1 percent in June, its lowest level in 18 months and a full percentage point below the Bank of Canada’s 2 percent target. Of 19 major components in the Consumer Price Index, the share with inflation rates below zero in June is the highest since 2013, even as the nation’s economic growth tops the Group of Seven leader board. The proportion of CPI components with a higher inflation rate relative to one year ago, meanwhile, hasn’t been this low since May 2013.

The Bank of Canada’s primary goal is inflation targeting, yet inflation itself doesn’t appear to matter much to policy makers, though their outlook for it certainly does. The bank hiked its policy rate to 0.75 percent in July amid sluggish headline inflation and with core gauges trending lower. Policy makers expressed confidence that price pressures would eventually move higher and emphasized that monetary policy changes affect activity with long and variable lags.

Broadening disinflation, however, undermines the case made by the Bank of Canada in its latest Monetary Policy Report that below-target price pressures are primarily the product of a select number of idiosyncratic factors.

Erik Hertzberg/Bloomberg

Excluding things like the Ontario government’s moves to cut electricity costs, a big slowdown in auto price inflation, and lackluster food inflation, underlying price pressures were actually running at around 1.8 percent, Governor Stephen Poloz said in the opening statement of the July 12 press conference.

“After careful assessment of the evidence, Governing Council agreed that a significant portion of the recent softness in our measures of inflation should prove to be temporary,” Poloz said.

Analysts rank persistently subdued price pressures as the biggest risk to the Bank of Canada’s outlook. The June data released Friday showed the three core measures the Bank of Canada uses to track underlying price pressures -- CPI common component, trimmed mean, and median -- edged higher from their the lowest average level since 1999.

Toronto-Dominion Bank senior economist Brian DePratto said Thursday that as of the May release, the bank’s internal proxy for CPI common component actually becomes marginally weaker, though not meaningfully different, once fruit, vegetables, meat, auto prices, and electricity -- measures the central bank highlighted as acutely depressing the headline reading -- are excluded from the calculations. This implies policy makers’ rationale for why headline inflation is weak doesn’t serve as a compelling explanation for why the core rates have also been decelerating.

"It was interesting to see the Bank shift away from its new measures of core inflation, particularly as they were introduced so recently with the intention of correcting perceived issues with CPIX and had been emphasized in communications earlier this year," he said by email.

Core inflation has been losing steam on a broad geographic basis across the country, Frances Donald, senior economist at Manulife Asset Management, said Thursday.

“The Bank of Canada has made it as clear as can be: their rate decisions are not based on where inflation is now, but where inflation will be a year and a half to two years from now,” she said in an email. “That approach buys the Bank of Canada a lot of time to talk through further weakness in inflation as transitory, temporary, or nearing the bottom.”

Donald said the bar to an October hike is “therefore probably quite low and more dependent on a two year outlook, which won’t likely materially change over the next few meetings, than it is on the next inflation print, for example.”

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