Bank of Canada debates changing inflation target
OTTAWA — After shocking markets with an interest-rate cut in January, Bank of Canada governor Stephen Poloz is considering whether to deliver another surprise: changing the central bank’s two per cent inflation target.
In what would be a challenge to global central bank orthodoxy, Poloz and his Governing Council colleagues are debating the merits of raising the inflation target for the first time since 1991.
The argument is that with Canada’s growth potential reduced by weak global demand, chances are higher that interest rates will get stuck at zero, limiting the central bank’s range of options in the event of another crisis.
Raising the inflation target would in theory help policymakers avoid extended periods at the so-called zero lower bound. The adjustment may be a tough sell, given the bank’s two decades of inflation-targeting success; among Group of Seven central banks, Canada alone is meeting its mandate.
“There would be a huge messaging challenge with any change,” said Craig Wright, chief economist at Royal Bank of Canada. “You want to convince markets that it’s a one-off move, that it’s not three per cent and next time we will go to four or five.”
Tinkering with the target would also be unpopular with debt investors, because inflation erodes the purchasing power of fixed coupon payments.
Ten-year Canadian government debt has returned 1.4 per cent this year, compared with 0.6 per cent for equivalent-maturity U.S. government debt, according to Bank of America Merrill Lynch data. Government bonds indexed to fluctuations in consumer prices — so-called real return bonds — are up 3.8 per cent this year in Canada, versus 0.9 per cent for inflation-linked Treasuries.
Adopting a higher target would, in addition to boosting some bond yields, weaken Canada’s dollar, economists and investors said.
Canada’s inflation target is defined as keeping price increases within a range of one per cent to three per cent.