November 3, 2011
Mandate of central banks undergoes tweaking as inflation stays stubbornly high in Canada and the U.S.
Chief Economist, CanaData
The two central banks in Canada and the United States can’t be happy with the latest inflation numbers, since they remain so elevated.
According to Statistics Canada, September’s year-over-year increase in the all-items Consumer Price Index (CPI) was +3.2%, up from +3.1% in August. The core rate also rose, to +2.2% from +1.9%.
The core rate omits highly volatile items, mainly in the food and energy categories, that are either uncontrollable (e.g., the effect of severe weather on crops) or determined externally (e.g., geopolitical crises elsewhere in the world that alter the price of oil).
The comparable figures in the U.S., according to the Bureau of Labor Statistics, were +3.9% for the all-items CPI in September, versus +3.8% in August, and +2.0% for the core rate (i.e., all items less food and energy), the same as the month before.
In other words, three of the four major inflation indicators continued to climb in September while one stayed flat.
The energy price sub-index in Canada fell from +13.4% in August to +12.5% in September. In the U.S., it rose to +19.3% from +18.4% the prior month.
Gasoline prices in Canada were +22.7% year over year in the latest month, almost the same as in August (+22.8%), while in the U.S. they were +33.3%, up from +32.4% in the preceding period.
The target rate for the overall price increase on a year-over-year basis, whether stated officially or not – which it is in Canada and isn’t in the U.S. – is +2.0%.
In theory, interest rates are supposed to be adjusted to bring about such a rate of price gain.
Stated in the vernacular, the traditional role of a central banker is to be a “worry-wart” about inflation.
In the circumstances of the last couple of years, that notion has largely gone out the window.
Sluggish growth is taking precedence when it comes to setting interest rate policy.
The Fed has already stated it will be holding nominal rates near zero percent out to mid-2013. (In inflation-adjusted terms, they are significantly negative.)
Conventional wisdom would hold that the Bank of Canada has little option but to follow the U.S. lead.
The thought-process is that further rate increases – they underwent some upward adjustment in the summer of last year – in Canada before the U.S. would drive up the value of the Canadian dollar, hampering the export sales of Canadian manufacturers.
However, the value of the Canadian dollar versus the greenback has already been clipped. What was once headed towards $1.10 US has now fallen back under $1.00 US.
This provides some wiggle room, if inflation does persist in Canada too long and too high.
Both Mr. Mark Carney (Governor of the Bank of Canada) and Mr. Ben Bernanke (Chairman of the Federal Reserve) are hoping and expecting prices to moderate.
The Bank of Canada’s latest Business Outlook Survey found firms are anticipating their output prices will rise at a slower pace over the next 12 months than during the previous dozen months.
Furthermore, considerably fewer firms than in earlier surveys think commodity prices will put upward pressure on input costs.
Moderation, therefore, will be achieved mainly through lower commodity prices.
Debt concerns in Europe, the near-gridlock in U.S. politics and tighter monetary policy in China are reducing prospects for growth around the world.
Base metals, precious metals, iron ore, global oil, aluminum and a host of other raw materials and semi-finished goods and products have already experienced price pull-backs.
On the inflation question, the Fed is sitting a little easier than the Bank of Canada. The Fed already has a double objective – to work at keeping the rate of price advance under wraps but also to gear interest rate policy towards creating jobs.
The Bank of Canada’s mandate has been to steer inflation towards one clear target, +2.0% on average.
Reports out of Ottawa suggest the BOC’s marching orders – undoubtedly with the input of Mr. Carney - may be undergoing a “tweaking”.
The time horizon for raising or lowering the +2.0% price-change target may become open to more leniency and an element of jobs-watching to stimulate employment will likely be more prevalent.
One suspects that taking into account the impact of interest rate moves on the value of the loonie has already been a bigger component of the Bank of Canada’s decision-making process than has ever been admitted.
For more articles by Alex Carrick on the Canadian and U.S. economies, please see his market insights. Mr. Carrick also has an economics blog. His lifestyle blog is at www.alexcarrick.com
(CPI & CPI-U not seasonally adjusted)
Chart: Reed Construction Data - CanaData.
(CPI & CPI-U less food and energy not seasonally adjusted)
Core inflation in Canada is as defined by the Bank of Canada. It is the Consumer Price Index (CPI) excluding the eight most volatile components: fruit, vegetables, gasoline, fuel oil, natural gas, intercity transportation, tobacco and mortgage interest costs. It also excludes the effect of changes in indirect taxes on remaining items.
Chart: Reed Construction Data - CanaData.
