MNI INTERVIEW:BOC Decision Will Overlook CPI Jump- Ex Official

The Bank of Canada will stick to the view that the strongest inflation since 2003 will be short-lived at next week's rate-setting meeting, balancing language about faster-than-expected recent gains with a cut to its economic growth forecasts, former central bank researcher and CIBC Senior Economist Royce Mendes told MNI.

That mixed view of the economy will justify Governor Tiff Macklem affirming forward guidance about holding the record low 0.25% policy rate until the second half of next year, Mendes said. While inflation reached 4.4% in September, GDP shrank in the second quarter and it's almost unheard of for the Bank to raise interest rates with the latest figures showing economic contraction.

"These are exactly the types of things that the Bank of Canada tries to look through," to focus instead on "what the underlying rate of inflation is," said Mendes, who at the BOC was a foreign reserve portfolio manager and principal researcher in the financial markets branch.

While inflation has topped the Bank's 1%-3% target band for six months now, policy makers can also point to the "common" core CPI that is just 1.8%, he said. That common measure is seen as being most closely linked to the economy's potential output, one of the conditions Macklem has set along with stable 2% inflation for raising rates next year.

CAN'T FIX BROKEN CHAINS

"Monetary policy cannot fix the issues with supply chains. However, it can help support further healing in the real economy," Mendes said. "It's likely that they will leave that conditional commitment to keep rates on hold, until later in 2022 in fact."

Bond investors and analysts at Desjardins and Capital Economics recently advanced their predictions for a rate increase, citing inflation and a BOC survey where almost half of firms said price gains will exceed 3% over a two-year horizon. Two-year Canadian government bond yields have climbed 43bps this month to 0.81% and bankers' acceptance contracts price a rate hike by March.

Macklem's comments last Thursday about inflation being narrow and transitory are further evidence that's what the Governor intends to lay out next week too, Mendes said. The view of manageable underlying pressures will come with other comments from the BOC that inflation will be elevated for a little while longer, he said.

"They will need to acknowledge the higher-than-expected rate of inflation and it is lasing longer than they previously envisioned," Mendes said. "There are going to be even more price pressures in October with the flow-through from commodity prices into consumer prices and then potentially for supply-chain disruptions to actually show up more."

The rate decision is at 10am on Oct. 27, including the first return to a media lock-up and an in-person press conference since the pandemic. Monetary hawks will get some other news, with the BOC expected to taper QE to a pace that stabilizes the size of the balance sheet.