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Last week the Bank of Canada (BoC) and our federal government agreed to extend the Bank’s existing inflation target of 2% and to maintain its existing inflation-control range of 1% to 3% for a new five-year period.
This was largely expected and on its own might not warrant mention in my weekly Monday updates. But the Bank also announced a significant change in the measures that it will use to monitor our overall inflation as part of its formal inflation review, and that is noteworthy for anyone keeping an eye on Canadian mortgage rates.
The BoC’s primary mandate is to maintain price stability, which is otherwise referred to as keeping inflation under control, and it uses specific measures to gauge whether this is happening. So if you are trying to figure out where mortgage rates may be headed, these measures provide the clearest indication of the Bank’s current bias (toward raising rates, lowering them, or standing pat).
In future, instead of relying on the traditional Consumer Price Index (CPI) total inflation and core inflation statistics, the Bank will now use three more detailed measures called CPI-common, CPI-trim and CPI-median. The Bank believes that these core measures will: 1) more “closely track long-run movements in total CPI inflation”, 2) “be less volatile than total inflation and capture persistent movements in inflation”, 3) “be related to the underlying drivers of inflation, notably the output gap”, and 4) “be easy to understand and explain to the public”.
Of all of the Bank’s justifications for adopting what it feels are more accurate measures, I thought the point about wanting to use measures that more closely relate to the output gap was the most important. The output gap measures the difference between our actual output and our maximum potential output, and the Bank would typically be expected to raise rates on or about the time that this gap closes. Our traditional inflation gauges, core and total CPI, have not tracked as closely to the output gap in recent years as would be expected, and I suspect that this was the main impetus for seeking more accurate gauges.
Bluntly put, if CPI-common, CPI-trim and CPI-median provide us with better indications of when the BoC might raise or lower its policy rate, I’m all for it. To that end, since these new measures will be important for mortgage rates going forward, let’s try to understand each in a bit more detail.