Inflation to 2% within a year? It adds up, say economists

Persistently low inflation has been puzzling to central bankers as they now wrestle with whether to gradually tighten monetary policies.

The BoC joined the lifting camp on Wednesday when it raised its key lending rate by 25 basis points to 0.75%, and said inflation — which averaged 1.4% in Q2 — could climb “close” to its 2% target by the middle of 2018. Ambitious words, no?

Inflation has been dampened by the forces of globalization, particularly competition from China and the “Amazon-ization” of retail, which has put downward pressure on the price of goods.

These global factors have been a big reason for low goods prices, CIBC economists say in a market note on Thursday. Goods inflation has been more muted than services inflation for decades, the economists say, noting: “there’s nothing that unusual about Canadian goods inflation (excluding food and energy) to be trending at close to 0%.”

Read: BoC sounds bullish as key rate hiked to 0.75%

The BoC, in its monetary policy report this week, said the inflation slowdown appeared “to be mostly temporary,” referring to heightened food price competition, electricity rebates in Ontario and lower in automobile price inflation. Together, those factors reduced inflation by 0.7 percentage points between Q1 and Q2 2017, the BoC said.

TD economists add in a note that weak inflation is a key risk to the central bank’s outlook. “[W]hile the macroeconomic backdrop supported a tightening of monetary policy, the inflation outlook did not. Clearly the Bank of Canada is placing more weight on the growth side of things,” the TD economists say.

RBC economists say they expect the BoC to continue with another rate hike in October, then hit pause on their tightening cycle “until they have greater confidence that inflation is heading to their 2% target on a sustained basis.”

Read: Big banks follow BoC, raise mortgage rates

But the CIBC economists say 2% inflation is likely to happen sooner rather than later. Accounting for housing price gains, unit labour costs and higher oil prices, they point to spring 2018.

“By pushing the C$ stronger, the Bank of Canada’s rate hike may have delayed achieving its 2% inflation target. But not for long,” CIBC says. “For each of the issues we looked at, the impacts are in the range of a decimal place or two on the CPI. But when added together, they’re material enough to push CPI inflation above the 2% target by next spring.”

Be ready to adjust your portfolios.

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