Fundamental factors continue to drive inflation

MONTREAL — Inflation has repeatedly fallen short of the Bank of Canada’s two per cent target in recent years, but governor Stephen Poloz said Tuesday fundamental factors are continuing to drive price growth.

In a luncheon speech to CFA Montreal and the Montreal Council on Foreign Relations, Poloz said the fundamental drivers of supply and demand, as well as short-term factors, can explain the movement in prices and that the popular perception that inflation has become inexplicable is exaggerated.

“In part this perception reflects a misunderstanding of the accuracy with which economists can predict inflation and a misunderstanding of the precision with which central banks can control it,” he said according to a prepared text of his speech released in Ottawa.

Inflation in Canada slowed over the first half of this year and remained in the lower half of the Bank of Canada’s target range even as the economy grew quickly.

However Poloz said that there have been a number of one-time factors including below-average food inflation and the Ontario government’s reduction in electricity prices that helped keep inflation in check.

“The bottom line is that fundamental drivers of inflation, along with some special factors we can identify, can explain the recent behaviour of inflation reasonably well,” Poloz said. “Certainly the remaining shortfall is well within a reasonable margin of error.”

Poloz also said there may also be some drag on inflation from globalization and digitalization, which the bank is studying.

“Over time, as we accumulate data, we may be more able to identify and statistically quantify these effects,” he said.

The Bank of Canada aims to keep inflation at two per cent, the midpoint of a range of one to three per cent, by making changes to its key interest rate target.

In keeping the rate on hold last month, the Bank of Canada said less monetary policy stimulus will likely be required over time, but that it will be cautious in making future adjustments to the policy rate and be guided by the incoming economic data.

“A lot of pieces need to fall into place before we can be certain that the economy has made it all the way home,” Poloz said Tuesday.