Has the Bank of Canada conquered inflation? It's complicated

Whether you are a homeowner facing the cost of renewing a mortgage or a business financial officer looking to renegotiate an essential loan, rising interest rates are causing a world of hurt for Canadian borrowers.

The latest data out Wednesday showed inflation had plunged to a two-year low of 3.4 per cent, a trifling few decimal points away from the Bank of Canada's one-to-three per cent target range. So why doesn't it just stop the pain?

"The bigger question is: Does the Bank of Canada believe that it can bring inflation back to two per cent without creating recession — and [it] has to ask itself what is the cost of further rate hikes?" Frances Donald, global chief economist at Manulife Investment Management, said in a CBC News interview shortly after the release of the consumer price index (CPI) data.

A lot of smart people in the financial sector seem to think a recession is coming. And yet a lot also think that before that, central bankers here, in the United States and overseas are going to raise interest rates some more.

The fact is, fighting inflation is complicated and politically divisive. And for central banks, it becomes even more complicated and politically divisive as inflation gets closer to their target, because rate hikes hurt more for less obvious reward.

As Donald points out, higher interest rates won't end Russia's war on Ukraine or fix a devastating disease in the California orange crop driving up prices or keeping them high.

There are few inflation riddles harder to solve than the fact that the Bank of Canada's own interest rate hikes are actually driving inflation higher, with the mortgage cost component of the CPI climbing 30 per cent in the latest Statistics Canada data.

"If you take out mortgage interest rate costs, then inflation is running much closer to 2.5 per cent," Donald said.

The problem, said Stephen Tapp, chief economist with the Canadian Chamber of Commerce, is that there are plenty of signs that inflation has not gone away. And it's more complicated than looking at the headline number.

I spoke to Tapp because he helped explain the concept of core inflation back in 2022, and why it showed that the new generalized rise in prices at the time was worrying to Tiff Macklem, governor of Canada's central bank.

Back then, headline inflation led the way, driven by volatile segments like oil and gas following the Russian invasion.

This time, the fall in gas prices makes it look as though inflation is tumbling. But overall price pressures demonstrated by core inflation are actually higher than the headline inflation number — and the Bank of Canada is worried they could become stuck.

Survey data from the Chamber of Commerce shows that businesses expect their costs, including the cost of labour — which is currently rising at about five per cent — will mean they'll have to charge more over the coming three months.

"They suggest businesses still face broad-based cost pressures — and corporate pricing behaviour that the central bank's been looking to normalize is far from normal at his point," Tapp said.