By Randall Palmer
OTTAWA, July 21 (Reuters) - The Bank of Canada has come
under fire for its increased reliance on an inflation gauge that
some economists say sows confusion in financial markets and
could eventually lead to monetary policy errors.
The central bank, which angered many forecasters in January
with a surprise rate cut and eased again this month, has a
mandate to control inflation, measured by the country's consumer
price index (CPI). It also uses a core-CPI measure that strips
out some volatile items.
Bank of Canada policymakers have put less onus in recent
months on these public measures, pointing to the bank's own
calculation of an "underlying trend in inflation."
They say this measure, which excludes transitory factors
like meat shortages and the effect of a weakening Canadian
dollar, gives a clearer picture of slack in the economy.
But some economists say its use effectively shifts the goal
posts, making it harder to interpret how Governor Stephen Poloz
will react to data and increasing the risk interest rates could
stay low for too long.
"If the economy was in better shape, and for whatever reason
they didn't want to raise rates, what's to keep them from
understating where they believe underlying inflation is?" asked
Bank of Montreal senior economist Benjamin Reitzes.
The Bank of Canada's is supposed to keep inflation at the
midpoint of a 1 percent to 3 percent target range. While annual
inflation was at just 1.0 percent in June, core-CPI was 2.3
percent and has run above the 2 percent target since August.
ID:nL2N0ZX0C4
But the bank estimated underlying inflation was 1.5 percent
to 1.7 percent when it cut rates on Wednesday, and said much of
the difference with core-CPI is due to currency weakness, which
boosts import prices.
Combined with the bank's decision to drop forward guidance,
the use of an unpublished underlying trend means less
transparency, said David Tulk, chief Canada macro strategist at
TD Securities.
"It is unorthodox to be using a measure that cannot be
calculated by others," Tulk said. "Since they model the currency
pass-through and other one-time effects, their underlying
measure cannot be easily replicated."
In response to the criticisms, the Bank of Canada said that
while it targets total inflation, underlying inflation helps it
understand "noise" from temporary factors.
"Our use of multiple measures of inflation, which we clearly
explain, helps us avoid making monetary policy errors - it
doesn't increase the risk of making them," spokeswoman Louise
Egan said.
"This type of analysis is not new for the Bank. Our
challenge has always been to look through the temporary effects
and aim our policy at the movements in inflation that are
persistent."
CIBC World Markets Chief Economist Avery Shenfeld sees some
justification for looking through the depreciation effect, but
takes issue with excluding other things like meat and phone
costs.
"That practice could down the road have the Bank of Canada
ignoring an inflation trend that wasn't as temporary," he said.
TD's Tulk said the fact core inflation was above 2 percent
at the time added to the surprise of the January cut and noted
that other central banks tend to focus on public inflation
gauges.
The U.S. Federal Reserve looks mostly at core PCE (personal
consumption expenditures) inflation and the Reserve Bank of
Australia at two measures of underlying inflation in addition to
total CPI inflation.
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Canada inflation/central bank rate graphic: http://link.reuters.com/cut67s
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(Editing by Jeffrey Hodgson and Lisa Shumaker)