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Move along, inflation watchers, nothing to see here

While the next Bank of Canada governor may not receive the same flattering comparisons to George Clooney that Mark Carney has enjoyed, hordes of observers will still be watching his or her every move – particularly on the eight dates each year when he or she announces the central bank's key interest rate.

For months, the bank's announcements have suggested a rate hike is in the offing. But there was widespread speculation before the last announcement, on Dec. 4, that this language would be removed in a signal that Canada's recent economic downswing has taken its toll on expectations and removed the need for higher rates.

That wasn't the case. The bank stuck to its usual warning that "over time, some modest withdrawal of monetary policy stimulus will likely be required" – but observers don't see any real danger of higher rates any time soon.

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In fact, CIBC World Markets chief economist Avery Shenfeld says that neither Mr. Carney nor his successor will need to worry about raising interest rates until 2014. The reason? Nosediving inflation has removed the need for higher rates. Measured by the consumer price index, Canada's inflation rate is hovering at 1.2 per cent, well below the bank's target of 2 per cent.

So is there a risk in the opposite direction? Could inflation fall so low that the bank might feel impelled to actually cut the key rate? That too is highly unlikely.

The most probable outlook for 2013 is that inflation will tick up gradually, as several factors that have held down prices go into reverse, Mr. Shenfeld argues in a recent report.

For instance, despite rising home prices, bargain-basement mortgage rates have put a lid on the shelter costs calculated by Statistics Canada as older, higher rate mortgages gradually roll into lower rate debt. However, the capacity of low rate mortgages to counteract higher home prices will dissipate over time. As a result, the rally in house prices since 2000 will gradually build itself into the inflation numbers.

In retail, the rise of online shopping and the rush of U.S. retailers into Canada in recent years has driven down prices and created a "one-time favourable price level adjustment for consumers," Mr. Shenfeld says. But now that online retailers and U.S. retailers are firmly established, prices are once again likely to start rising.

Mind you, the strength of the loonie will moderate any price increases. Having been at parity with the U.S. dollar for some time now, the Canadian currency "may still be playing a role as prices, ever so gradually, come to reflect the loonie's true buying power," Mr. Shenfeld said.

All of this, Mr. Shenfeld writes, will give Mr. Carney's replacement the luxury of waiting for the economy to pick up in 2013. He or she will probably neither have to push the key interest rate down further nor follow through on vague threats of a rate hike.

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About the Author

Josh O’Kane is a reporter with The Globe and Mail's Report on Business. Since joining the paper in 2011, he has told stories from New Brunswick to Nairobi. More


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