Statistics Canada’s latest data show that Canada’s inflation rate has rebounded faster than pretty much any forecaster expected. That includes the Bank of Canada – which probably pays more attention to the inflation trend than anyone.
But don’t expect the Bank of Canada to care very much about these numbers. The story told by these inflation figures isn’t the one the central bank has been waiting to hear.
Statscan reported Wednesday that Canada’s consumer price index (CPI) rose a brisk 0.3 per cent, seasonally adjusted, in October from September – lifting the annual inflation rate to 0.7 per cent. It might not sound like much, but that matches the highest pace since the COVID-19 crisis began – and well above the 0.4-per-cent annual rate that economists had anticipated.
This also puts inflation well ahead of the schedule in the Bank of Canada’s own forecasts, laid out in its quarterly Monetary Policy Report in late October. The bank estimated an inflation rate of just 0.2 per cent at the end of the third quarter – and predicted that it would stay there through the end of the year.
The Bank of Canada’s three measures of core inflation – designed to cut through month-to-month distortions to see the underlying inflationary trend – averaged 1.8 per cent in October. That puts them within spitting distance of the bank’s inflation target of 2 per cent – and they’ve been closing the gap for three straight months.
This is all highly relevant in the context of the aggressive monetary policies the Bank of Canada adopted to combat the impact of the pandemic – its record-low policy rate of 0.25 per cent, its quantitative easing program in which it is dampening market interest rates by buying billions of dollars each week of Canadian government bonds.
The bank has stressed, repeatedly, that its policies are entirely guided by its unwavering focus on the 2-per-cent inflation target. Indeed, this is its standard defence of the QE program, under which it has bought more than $170-billion of government bonds in the open market since April, and now holds about 35 per cent of the entire supply of federal bonds. This has led to charges from some quarters that the bank is effectively financing a dramatic rise in government debt. No, it’s all about achieving the inflation target, the bank counters; when that target comes into view on a sustainable basis, that will guide the bank to scale back its stimulus.
So, are we now seeing the target come into view – albeit still on a distant horizon?
The sustainable inflationary pressure that the central bank is looking for requires an economy that is closing in on full capacity. We are still a very long way away from full speed.
In October, employment was more than 3 per cent below February’s level, before the pandemic arrived. In September (the latest estimate available), gross domestic product was about 4 per cent lower than in February.
And remember that in February, the economy was operating modestly below capacity – meaning that even pre-COVID, underlying inflationary pressures weren’t much of a threat. We have a very long way to go before we have rising inflation built on the underlying capacity fundamentals – the kind of inflation about which the Bank of Canada will actually worry.
Which isn’t to say that the bank won’t be encouraged by the evidence in the October inflation data that its policies are having some of their desired effects. The impact is apparent in one of the biggest drivers of October’s inflation surprise: housing costs.
The bank’s success in driving down borrowing costs – both via its near-zero official interest rate and its buying of bonds – has served to reduce mortgage expenses. But they have also, more significantly, provided a strong incentive for home buyers – contributing to strong demand and significantly rising prices. Statscan’s homeowners’ replacement cost index, which reflects new home prices, jumped 1.4 per cent in October from September – the biggest one-month rise since 1991.
The bank is also well aware that the annual inflation rate is sure to head higher next spring, when the sharp drops in prices related to the pandemic – primarily fuel prices – wash out of the year-over-year comparisons. Consider that gasoline prices were down 12 per cent year over year in October; that’s a big drag on overall inflation that, come March, is poised to reverse and become a positive contributor to inflation.
But these are all small details in an inflation outlook, still intrinsically linked to the course of the pandemic. COVID-19 has forced the overall economy to run far below its normal capacity, and will continue to do so for many months yet. It’s only with the removal of containment measures that any return to full capacity can come back into view, and a meaningful discussion about inflation can be had.
Until that happens, don’t expect the Bank of Canada to be swayed by occasional inflationary blips in the inflation data.
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