Lagging inflation is no mystery, it’s just slow, Poloz says

Inflation hasn't mysteriously vanished, it is just proving slow to materialize as the global economy grapples with the aftershocks of the Great Recession, Bank of Canada Governor Stephen Poloz says.

"The popular perception that inflation has become inexplicable has been greatly exaggerated," Mr. Poloz told a meeting of financial analysts in Montreal Tuesday.

People expect too much of central banks in being able to accurately predict and control inflation down to "tenths of a percentage point," he added.

"Inflation targeting is an imprecise business," he said.

Mr. Poloz nonetheless insisted that the bank's policy of targeting 2-per-cent inflation is working just fine.

"The laws of supply and demand have not been repealed," he said.

Prices have remained stubbornly below the bank's target for most of Mr. Poloz's tenure at the central bank, which began in 2013. And now with unemployment back to prerecession levels and the economy operating at full capacity, inflation remains subdued, running at a 1.6-per-cent annual rate in September in Canada.

Indeed, inflation is the missing piece in the central bank's desire to raise its key interest rate to more normal levels. The Bank of Canada has hiked its overnight rate twice this year – to 1 per cent – reversing two quarter-percentage-point cuts it made in 2015 as the oil price shock rattled the Canadian economy.

"Governor Poloz walked a tricky line between defending the rate hikes he's already delivered as reasonable given the inflation outlook, while still acknowledging enough of a grey area in the forecast to be cautious about delivering the next move," Canadian Imperial Bank of Commerce chief economist Avery Shenfeld said in a research note.

"He concedes that wage inflation hasn't picked up in the usual way, but isn't convinced that it's not coming."

Mr. Poloz said last month that the bank intends to move cautiously on further rate increases as it looks for signs that wages and inflation are finally perking up.

Investors are now betting that the Bank of Canada will not hike again in 2017, and will move slowly next year.

"A lot of pieces need to fall into place before we can be certain that the economy has made it all the way home," Mr. Poloz said Tuesday.

"Home," he explained, is "at the intersection of full capacity and 2-per-cent inflation."

Persistently low inflation is no mystery, Mr. Poloz insisted. In Canada's case, it's the result of the "surprising persistence of excess capacity in the economy and the fact that inflation reacts to excess demand with a lag."

He pointed out that it takes up to two years for the central bank benchmark interest rate to have its "full impact" on inflation.

Mr. Poloz also said several temporary factors are keeping prices low, including low food inflation caused by intense competition and healthy crops as well as Ontario's lowering of electricity rates.

The Bank of Canada has investigated other possible sources of low inflation, including digitalization and globalization, and China's entry into the World Trade Organization. But so far the bank has found no evidence that these factors are statistically significant.

And yet Mr. Poloz acknowledged that "common sense tells you that globalization and digitalization are affecting prices."

He pointed out that companies operating in global markets face pressure to cut costs and hold down prices. As well, digitalization has lowered the cost of technology and made it easier to start new companies.

"When we put it all together, we see that inflation has been behaving well within the normal zone of statistical and policy tolerance," he said.​