MNI EXCLUSIVE: BOC to Resist CPI Overshoot Pledge: CD Howe

The Bank of Canada will likely resist pledging to an inflation overshoot next year when it renews policy goals, even though the economic recovery would be helped by that change, former advisers wrote in an upcoming paper from the C.D. Howe Institute obtained by MNI.

Governor Tiff Macklem and his deputies appear more likely to acknowledge it will take longer than the usual six- to eight-quarter timeframe to return inflation to the 2% target, while renewing the existing system where bygones are bygones. That's according to the paper by Steve Ambler, a former BOC special adviser and Jeremy Kronick, associate research director at C.D. Howe and a former BOC analyst.

Averaging inflation over two or three years including a temporary overshoot could be a credible pledge, the pair wrote in the paper. Canada was the first G7 nation to adopt inflation targets in the early 1990s and has mostly rubber-stamped renewal agreements with the government every five years since, in part because Canada has beaten the Fed, ECB and BOJ in meeting its target.

"The Bank will likely resist the idea of an inflation overshoot," Ambler and Kronick wrote in the paper. Still, "aiming for inflation to overshoot the target would help in the recovery."

"A concrete way to achieve this would be to move to target the average rate of inflation over a horizon of two or three years, which would lead to the partial correction of both undershoots and overshoots of the target," they wrote.

QE RISKS

The BOC already has some latitude because while 2% is the target, there is also a band from 1% to 3% around that mark and officials have sometimes noted the range is symmetrical.

The paper's other theme was laying out competing risks from QE. They include managing the recovery, dealing with potential political conflicts related to government bond purchases, and keeping inflation on track. The BOC is buying at least CAD5 billion of federal government bonds a week until the recovery is well established, and has programs to buy up to CAD50 billion of provincial government debt and CAD10 billion of corporate bonds.

It's "imperative" the government and the BOC agree to continue the 2% target, with monetary and fiscal policy more entwined than it's been in a long time, according to the paper. "To the extent that governments have borrowed using short-term instruments, rolling over their debt will become more expensive. For this reason, the Bank might come under pressure to keep its policy rate low." Governor Macklem has said the policy rate will remain at the lower bound of 0.25% until inflation is sustainably back at 2%, something BOC forecasts show could be several years away.

The BOC should also be looking for ways to wind down its record balance sheet of more than CAD500 billion, such as allowing repos to roll off the books and more active sales of longer-term debt. The asset purchases "bring on potential credibility and independence challenges," and QE by itself doesn't have a major impact on the economy, the authors wrote.