BoC’s rate policy is guided by inflation – but which one?

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The Bank of Canada's latest rate-decision statement is a reminder that, amid all the moving parts of an economy in a complex transition, inflation remains its policy bottom line – though there's still a question of which inflation we should be talking about.

I can already hear some central bank watchers protesting. Didn't the Bank of Canada, in holding its key rate steady at 0.50 per cent on Wednesday, also move its inflation discussion to the bottom of the rate statement – when in the previous 15 statements it had been at the top? Surely a change like that is evidence that the central bank is de-emphasizing inflation and focusing more on other concerns affecting monetary policy.

That's certainly what some observers suggested after the statement came out Wednesday morning. It's an interesting interpretation, but a wrong one.

After laying out the bank's views on the global economy, U.S. growth, commodity prices, exchange rates, financial conditions and Canada's economic state of affairs, the bank said that "in the midst of all these adjustments, inflation is in line with the bank's October outlook." In effect, it took all this disjointed information and focused it through the lens of its inflation outlook.

Now consider the penultimate sentence of the statement, the one that spells out the conclusion it came to with regard to its interest-rate policy. In its previous rate statement in October, it said: "The bank judges that the current stance of monetary policy remains appropriate." But in Wednesday's statement, that had become: "The bank judges that the risks to the outlook for inflation remain within the zone for which the current stance of monetary policy is appropriate."

It's not the first time it included inflation as the key focus in this conclusion – it also did so in the September statement – but it's a relatively new wrinkle. That's no accident.

Ultimately, what determines Bank of Canada policy isn't the collection of economic forces pushing and pulling against each other, but the implications of those competing forces on inflation. This is a central bank that formally and explicitly uses an inflation target of 2 per cent as its sole policy objective. Sometimes that message can get lost in the economic clutter. This tidying of the rate statement puts the bank's bottom-line policy issue where it belongs – almost literally on the bottom line.

But if the Bank of Canada is underlining its inflation focus, its statement also reminded us – perhaps inadvertently – that the bank's way of gauging inflation has become something of a moving target.

It talks about total consumer price index (CPI) inflation, which is what it officially targets. It talks about "core" inflation, which is the bank's "operational guide" to gauging the inflation target. In recent months, it has talked at length about what it calls "underlying inflation," the bank's increasingly prominent attempt to filter out temporary factors distorting CPI (chiefly, at the moment, the fall of fuel prices and the value of the Canadian dollar) and gauge true inflationary pressures. Many observers have become frustrated by what they perceive as the bank's shifting inflation goalposts; some have even grown suspicious that the bank is massaging inflation numbers to match its desired interest-rate trajectory.

Yet, conspicuously, underlying inflation was absent from Wednesday's policy statement. This raised a few eyebrows: Some observers wondered whether the central bank might be reconsidering its underlying-inflation obsession, going back to a simpler discussion about inflation measures.

That's probably wishful thinking from the underlying-inflation critics. The Bank of Canada is pretty committed to finding better ways to gauge inflationary pressures; it has been talking about this for a year now.

The absence of underlying inflation from Wednesday's statement more likely reflects the fact that the central bank has taken to updating its estimate of underlying inflation only in its quarterly Monetary Policy Reports (most recently 1.5 to 1.7 per cent, in conjunction with its October rate decision). Without another MPR until January, the bank simply had no new underlying-inflation estimate to share. Similarly, it made no reference to underlying inflation in its September (non-MPR) rate statement, but it resurfaced with the updated estimate in October.

It's a decent bet, though, that Bank of Canada Governor Stephen Poloz will get asked about underlying inflation, and its absence from the rate statement, when he holds a press conference next Tuesday in Toronto. Which might actually be productive, because the supposedly transitory factors distorting headline inflation are all over Wednesday's rate statement. The prospect of now-imminent U.S. rate hikes creates a monetary policy divergence that will keep downward pressure on the Canadian dollar. Oil prices are still groping for their floor. Canada's economy looks to have slowed, again, in the fourth quarter.

It all adds to the twists and turns to the inflation story, and how the Bank of Canada will tell it. If the bank's repositioning of its inflation message in Wednesday's statement draws new attention to the inflation discussion, then that might be the most constructive outcome from its decision to move a paragraph.