Interpretation of New Bank of Canada Statement

July 15, 2008

The main message is that no policy changes are pending in the short term, but a rate increase is eventually likely to be needed.  With the present 3.0% rate, officials project a convergence of core inflation from below and total CPI inflation from above upon the medium-term target of 2.0% sometime during 2H09.  Risks to the baseline inflation forecast are considered balanced.  The biggest surprise since the April Monetary Policy Report was published has been much higher commodity prices, which will lift total CPI inflation to a peak above 4.0% in 1Q09.  However, the statement asserts expected medium-term inflation remains anchored, and commodity prices are assumed not to keep climbing.  2008 growth has been revised downward to 1.0%, but projected inflation in 2009 of 2.3% and 3.3% in 2010 are similar to forecasts embodied in the April Report.  So above-trend growth gets restored in less than a year’s time, and full-capacity versus the present circumstances of excess supply is reached by the middle of 2010.  In order to prevent core and headline inflation from accelerating above the 2% target after that point, it will be necessary for economic growth not to exceed trend, and that will require a slowdown from the pace of growth anticipated in the year to mid-2010.  Monetary policy affects inflation with long and variable lags, meaning that a tightening from the present stance will be necessary in advance of 2010.  If commodity prices fail to flatten as assumed, monetary officials probably would need to act even sooner.  The claim of still-anchored inflation expectations is moreover not precisely accurate.  The Bank’s own quarterly business survey found 36% of respondents projecting inflation of more than 3% in the next 12 months, twice the number thinking such in the previous survey.  If there are further signs of eroding confidence in price stability, central bank officials would no doubt begin tightening sooner.  These are considerations for 2009, not the immediate months ahead when the likeliest scenario is for no change in the 3.0% key rate.



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