July 12, 2017 / 2:16 PM / in 5 months

Subdued inflation could be structural, Bank of Canada says

OTTAWA, July 12 (Reuters) - Higher global potential, technological advances and heightened competition may be contributing to subdued inflation in advanced economies, but more analysis is needed to figure out why price pressures are so low, the Bank of Canada said on Wednesday.

Attempting to explain why inflation has remained well below its 2 percent target, the bank said temporary factors like electricity rebates and competition among food vendors as well as global structural changes relating to technology were part of the puzzle.

“Over the projection horizon, these structural factors could exert disinflationary pressure in Canada and abroad that is not fully captured in the base-case projection,” the bank said in its quarterly Monetary Policy Report.

The bank, whose official mandate is to control inflation, raised interest rates on Wednesday for the first time in nearly seven years, even though inflation shows no sign of becoming a problem for the Canadian economy.

In explaining the contradiction of raising rates in the absence of inflation, the bank said it believed inflation would reach close to 2 percent in the middle of 2018 as temporary factors disappear.

It also warned that advanced economies may not be properly measuring global potential growth, which means there could be more excess capacity in the economy than policymakers realize.

“If lower inflation reflects increased global potential and heightened competition, it suggests higher living standards rather than signaling economic weakness,” the bank said.

It said a rebound in food prices and the end of electricity rebates in the province of Ontario will together add about 0.6 percentage point to inflation by the middle of 2018.

The closing of the output gap, now expected around the end of 2017, will also eventually boost inflation. The effect of excess supply would subtract 0.2 percentage point from inflation in the third quarter of 2017, it said.

“As excess supply is absorbed inflation is expected to return sustainably close to the 2 percent target,” it said.

But because the slowdown in inflation is being seen across advanced economies, common factors may be playing a role.

“One possible explanation is that inflation expectations may have drifted downward resulting from a long period of below-target inflation in many advanced economies,” the bank said.

It said structural advances may have boosted productivity in ways that are not readily measured, adding to global potential growth and “thus implying that there is more excess capacity than is captured by standard estimates.” (Reporting by Andrea Hopkins; Editing by Bernadette Baum)

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