Bank of Canada under fire for shift in inflation focus

Tue Jul 21, 2015 3:20pm EDT
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By Randall Palmer

OTTAWA, July 21 (Reuters) - The Bank of Canada has come under fire for its increased reliance on an inflation gauge that some economists say sows confusion in financial markets and could eventually lead to monetary policy errors.

The central bank, which angered many forecasters in January with a surprise rate cut and eased again this month, has a mandate to control inflation, measured by the country's consumer price index (CPI). It also uses a core-CPI measure that strips out some volatile items.

Bank of Canada policymakers have put less onus in recent months on these public measures, pointing to the bank's own calculation of an "underlying trend in inflation."

They say this measure, which excludes transitory factors like meat shortages and the effect of a weakening Canadian dollar, gives a clearer picture of slack in the economy.

But some economists say its use effectively shifts the goal posts, making it harder to interpret how Governor Stephen Poloz will react to data and increasing the risk interest rates could stay low for too long.

"If the economy was in better shape, and for whatever reason they didn't want to raise rates, what's to keep them from understating where they believe underlying inflation is?" asked Bank of Montreal senior economist Benjamin Reitzes.

The Bank of Canada's is supposed to keep inflation at the midpoint of a 1 percent to 3 percent target range. While annual inflation was at just 1.0 percent in June, core-CPI was 2.3 percent and has run above the 2 percent target since August.

But the bank estimated underlying inflation was 1.5 percent to 1.7 percent when it cut rates on Wednesday, and said much of the difference with core-CPI is due to currency weakness, which boosts import prices.   Continued...