Deciphering Canada's core inflation puzzle
The variety of measures used by the Bank of Canada to track and measure inflation can complicate timing decisions and muddle market and economist forecasts, leading market observers have suggested.
The central bank uses no less than six indexes to assess underlying price pressures. Governor Tiff Macklem stresses the nuanced nature of core inflation, cautioning against fixation on a specific indicator.
Benjamin Tal, deputy chief economist of the Canadian Imperial Bank of Commerce (CIBC), highlighted the uncertainty surrounding the bank’s decisions in an interview with BNN Bloomberg. “The bank can always find a number to suit its narrative,” said Tal. “You never know on which side of the bed they’ll wake up.”
Core inflation indicators aim to offer stable insights amid volatile price swings, excluding items like food and energy to reveal broader trends. However, interpreting these metrics remains challenging.
Measuring inflation for rate adjustments
Two preferred indexes, CPI-trim and CPI-median, edged up to 3.65% year-over-year in December, impacting market expectations for rate adjustments. As a result, traders pushed back on predicting Canada rate cuts. Following the US inflation report, markets are not fully pricing in a cut until September.
Macklem has also refrained from setting a specific threshold for rate cuts. “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.”
According to Bloomberg, analysts like Stephen Brown of Capital Economics and Veronica Clark of Citigroup Inc. employ various methodologies to forecast inflation and anticipate rate shifts, reflecting the complexity of the economic landscape.
Brown was expecting the first cut in April, but has shifted to June following the release of a report on jobs in January. Meanwhile, Clark focuses on the core rates and also on the three-month moving measures. With these, she expects 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,” Clark told Bloomberg.
The Bank of Canada has a history of revising its core inflation metrics, adapting to evolving economic conditions. The central bank, working with Statistics Canada under the former governor Stephen Poloz introduced the new “preferred measures” of core prices in 2017 to replace CPIX.
By the end of 2022, one of these, CPI-common, was discarded after revisions and a major disconnect from headline inflation. From mid-2023, the bank has used the three-month moving average of trim and median.
Tal has described the myriad core metrics as an “inflationary buffet.” He notes the hawkish central bank may choose to focus on those with above 3% inflation, while a less hawkish bank may choose to focus on those around 2%.
As the bank navigates through diverse inflationary signals, Macklem’s communication tone becomes crucial for market reactions and economic projections, according to BNN Bloomberg. The evolving narrative shapes expectations more than raw data releases.
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