April 18, 2015 / 12:32 AM / 3 years ago

UPDATE 1-Bank of Canada ignores C$-tied rise in March core inflation

(Adds comments about economic forecasts, whether more rate cuts needed)

By Randall Palmer

WASHINGTON, April 17 (Reuters) - The Bank of Canada will ignore that part of the surge in March core inflation which is due to the fall in the Canadian dollar, Governor Stephen Poloz said on Friday, adding that the growing output gap was exerting downward pressure on inflation.

Canada’s core inflation rose to 2.4 percent in March from 2.1 percent in February, putting it well above the central bank’s 2 percent target. Poloz, however, said the jump was primarily due to higher prices for cars, which are sensitive to exchange rates.

The Bank of Canada does not see price rises from the exchange rate pass-through as fundamental inflation, he told journalists on the sidelines of the spring meetings of the International Monetary Fund and World Bank in Washington.

“As far as I know, the output gap’s actually getting bigger as we sit here, not smaller, so the fundamental forces on inflation are downward, not upward,” Poloz said.

The increase in the gap between the economy’s output and its potential, which he expects to be short-lived, is due to the harsh effect of the oil price crash on investment and income in oil-rich Canada.

Falling oil prices have weighed on the Canadian dollar, which has fallen by about 12 percent against the U.S. dollar since last June.

Poloz held interest rates steady on Wednesday after a surprise cut in January, despite his estimate that economic growth ground to a halt in the first quarter because of the drop in oil prices. He is banking on the economy picking up steam in the rest of the year.

On Friday he deflected criticism from some economists that the central bank was too optimistic to predict growth bouncing back to 1.8 percent in the second quarter and to 2.8 percent in the third quarter.

He said the bank’s growth estimate for 2015 as a whole, at 1.9 percent, is close to and even more conservative than the 2 percent average growth estimate submitted by a range of economists to Finance Minister Joe Oliver for his 2015-2016 budget.

“It makes me wonder why anybody would be skeptical of the pattern that we’ve laid out when the average works out to be virtually the same,” Poloz said.

When he cut the overnight lending rate in January, he referred to it as insurance against the effects of oil prices, and he was asked on Friday how bad things have to get in coming quarters for him to take out more insurance, or cut again.

“It would have to be evaluated in full-, full-blown analysis of what has happened to the output gap and our projection of the output gap,” he said.

“If it’s going to close in a reasonable space of time, and get inflation stably on our 2 percent target, then we’re good.”

The situation in January was highly uncertain, with oil prices even $10 a barrel below the assumption the central bank made at the time and with no certainty of where they would settle.

“So it was a pretty nervous thing. There were so many things moving at once, so the term ‘insurance’ captured the situation well,” he said.

“Now that the dust has settled a little bit and we can get a better look at it and re-run everything, it appeared as we said on Wednesday to be about the right amount of insurance to get the output gap on track to late 2016 closure.”

The bank’s next interest rate decision is on May 27. (Reporting by Randall Palmer; Editing by Paul Simao)

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