February 22, 2024
The Bank of Canada says it’s watching core inflation closely as it weighs when to cut interest rates, but a mixed bag of measures gives it options on timing and clouds the outlook for markets and economists. The central bank has no less than six indexes it monitors to get a grasp on underlying price pressures. Governor Tiff Macklem has pushed back against focus on a specific indicator, describing core inflation as more of a “concept.”
While that reflects the bank’s need for certainty before declaring victory over inflation, it can also limit transparency — there’s no lodestar key to policymakers’ thinking that would compel them to cut. “The bank can always find a number to suit its narrative,” Benjamin Tal, deputy chief economist at the Canadian Imperial Bank of Commerce, said. “You never know on which side of the bed they’ll wake up.”
Core inflation measures are important guideposts for economists — they’re meant to strip out more extreme price fluctuations to provide a better sense of where price pressures are headed. Food and energy, for example, are volatile goods with month-to-month changes that don’t necessarily represent the broader inflation trends.
The average of two of the bank’s preferred metrics, CPI-trim and CPI-median, ticked up to 3.65 per cent year over year in December from an upwardly revised 3.55 per cent a month earlier. The release prompted traders to push back bets on Canada rate cuts — and after Tuesday’s hot U.S. inflation report, markets are not fully pricing in a cut until September.
But Macklem has said he wouldn’t put a specific number on what level of core inflation would prompt a lowering of the benchmark interest rate from the current five per cent. “What I’ve emphasized is underlying inflation is more of a concept than a measure,” he said in January. “We’re looking for continued evidence that inflationary pressures are easing and we’re looking for clear downward momentum.”
Stephen Brown of Capital Economics parses through core inflation data each month, running his own calculations to strip out mortgage and rent components. (Brown was expecting the first cut in April. His forecast shifted to June following the release of January jobs data.) Failing to exclude those measures means the bank “is going keep interest rates high for too long and condemn the economy to a weaker period than is needed,” Brown said.
Last week, Macklem signalled officials may be starting to reach similar conclusions, saying monetary policy can’t solve housing shortages that are driving up costs. For some economists, that suggests policymakers may consider looking beyond shelter inflation as they weigh how long to keep interest rates at current levels.
Veronica Clark at Citigroup Inc. focuses on the core rates themselves, as well as the three-month moving measures. She’s expecting the first cut in July. “It is not as easy to forecast core inflation in Canada because the components change every month. It’s not as easy as excluding food and energy,” she said. CPI excluding food and energy is a measure that’s often used for intercountry comparisons of underlying price pressures.
The central bank also has a track record of abandoning some core inflation measures while it redirects focus on others. Working with Statistics Canada, the bank under former governor Stephen Poloz introduced three new “preferred measures” of core price trends in 2017 to replace CPIX, which continued to decelerate even as policymakers started hiking rates.
One of these, CPI-common, was discarded at the end of 2022 after substantial revisions and a major disconnect from headline inflation, which hit a four-decade high that year. In mid-2023, the bank started to emphasize the three-month moving average of trim and median.
In a note last month, CIBC’s Tal described the myriad core metrics as an “inflationary buffet.” A hawkish central bank might choose to focus on those with above three per cent inflation, while a less hawkish bank will focus on those closer to two per cent, he wrote.
“Therefore, the tone of governor Macklem’s press conference will become increasingly more important than any new data releases.”
