Despite strong job creation and 2% inflation, Bank of Canada has room to hold rates: Don Pittis

Bank of Canada governor Stephen Polozon Friday fulfilled aceremonial role by unveilinga glamorous new $10 bill to celebrate the country's sesquicentennial.

This week, Poloz willdischarge an even more fundamental duty, announcingthe policy that makes sure the fancy10, and the rest of Canada's money, retains its value.

With inflation at two per cent, with the economy continuing to crank out jobs, and with continuing signs of an overheated housing market in many Canadian cities, the governor will face growing pressure to raise interest rates.

So far Poloz has shown no inclination to follow U.S. Fed chair Janet Yellenin her move to put rates higher. In fact the last time he talked about changing rates, he was discussing a cut.

"Especially with inflation being below target for a prolonged period, yes, a rate cut remains on the table and it would remain on the table as long as those downside risks are still present," said Poloz in January.

Even though a widening spread between U.S. and Canadian rates should also widen the gap between the two currencies, the metrics the Bank of Canada uses to guide its policymeanthe governor may be in no rush to change Canadian rates.

Despite a recovery in trade and a job market that keeps growing, Polozrepeatedly offers a gloomy outlook on Canada's economic future, worrying about "serial disappointment" every tme the economy starts to show signs of health.

Talking the dollar down

That has led some to say the governor is talking the dollar downusing words rather than interest rates to makeCanadian exports cheaper on world markets. Polozhas denied doing that.

His gloom seemedjustified after thelatest trade numbers showedCanada moving into deficit after three months of surpluses.

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But on Friday, an unexpected boom in Canadian job creation told a different story.

"The Canadian economy is showing lots of momentum andthese latest employment numbers are part of that picture," said CIBC chief economist Avery Shenfeld.

Shenfeld says we are close to the point where employers will have to start bidding up the price of labour, one of the triggers for priceinflation.

"We're already at the kind of unemployment rate that would typically require employers to pay up for additional workers by raising wages, and that's what they're reporting in this survey that comes out separately of employers," said Shenfeld.

As to rising house prices, BMO economist Robert Kavcic has scoffed at Poloz'sassertionthat low interest rates are not responsible. Kavcic says the Bank of Canada's statements that rates will stay low arejust encouraging home buyers to bid up prices.

Mathematical magic

Headline inflation, the increase in the actual cost of the things Canadians buy,has reached two per cent. Rising rents in some places and rising prices for essential products leavemany consumers feeling their wages aren't keeping up.

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But a look at the statistics the Bank of Canada uses to make its rate decisionjustifiesPoloz's intransigence.

Until the end of last year, the bank used to use a measure of coreinflation which was regular inflation with a few notoriously volatile items in the standard basket of goods, including energy, stripped out.

As of October 2016, it has beenreplaced with three core measures:

• CPI-trim, as it's called, simply chops off what are sometimes called the long tails of price data, using the 60 per cent of CPI components that are the least unusual that month. That means things such as a sudden frost in the orange groves a poor indicator of overcapacity in the Canadian economy will not influence the Bank of Canada's decision.
  
• CPI-median lines up the sectors in order of their one-month volatilityand uses the middle one.
  
• CPI-common is a mathematical marvel created by the Bank of Canada, churned out byStatistics Canada computers, that uses historical data and a 55-dimensional regression to tease out a common inflation factor that fits them all.

All three leave out tax increasesbecause higher taxes don't indicateeconomic overcapacity pressure.

But most importantly, all threecore measures of CPI show the economy is nowhere near the verge of overheating.

Besides, two per cent is just the midpoint in the target range.Poloz has the latitude to let inflation go as high as three.

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Of course, that does not let him off the hook entirely. Research indicates small risesin rates can take months or years before they work through the economy andbegin to restrain prices.

While almost no one expects the governor to start raising rates this week or anytime soon, a first step to watch for isa greater emphasisthat such rate hikes havenow become a serious possibility.

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