Investors caught off guard as Bank of Canada’s inflation indicator fails

Even while the Bank of Canada claimed it was sticking with its core measures, substantial and frequent changes have damaged the credibility of a fundamental yardstick, forcing Canadian economists to search for a reliable method to track underlying inflation.
The CPI-common, CPI-trim, and CPI-median are the three core inflation indicators that the Bank of Canada prefers. Since the beginning of this year, the CPI-common, which was formerly hailed as the finest indicator of the health of the economy, has undergone numerous changes.
The measure’s inefficiency when prices rise quickly is highlighted, analysts said, raising doubts about its value. The same adjustments demonstrate that price moves initially described as temporary turned out to be not at all transitory.

The large upward revisions to common, according to BMO Capital Markets senior economist Doug Porter, have rendered it worthless as a policy indicator. At the beginning of the year, it missed the boat on inflation and gave policymakers completely the wrong message.
CPI-common measures all of the consumer price index’s moving parts and filters out those that appear to be altering as a result of sector-specific events to calculate core inflation. CPI-trim and CPI-median, on the other hand, function by removing severe price swings.
When inflation was almost at the Bank of Canada’s 2% objective, the CPI-common was seldom ever updated. However, it is presently being amended and reviewed again each month as a result of prices rising more quickly than they have in decades.
Statistics Canada claimed these modifications are necessary because the statistical system is now detecting more price co-movement, necessitating a monthly recalculation of the entire series.
The agency tacked on by saying, this essentially indicates that more CPI items and services are moving in tandem than in the past or that inflation is currently more broadly based.
According to spokesman Alex Paterson, the Bank of Canada will remain to examine all of its core inflation metrics as it attempts to bring inflation back to goal notwithstanding the modifications.
He continued in an email that the Bank utilises three separate core measures so they can assess the underlying trajectory of inflationary pressure while taking into account various price perspectives.
On Thursday, Governor Tiff Macklem is scheduled to deliver a speech about the state of the economy, followed by a news conference.
The CPIX, which is the flagship inflation statistic eliminating eight of the more volatile compounds in a basket of regularly used items, was replaced by the three core measures in 2017.
CPI-common has been the “least volatile” and appeared less susceptible to revisions or sector-specific shocks, according to a 2019 analysis by Bank of Canada economists that analysed the performances of seven core indicators from 1992 to 2018.
However, it was created at a time when inflation hardly ever strayed from the Bank of Canada’s target range of 1% to 3%. For the past 17 months, inflation has been above 3%; in August, it reached 7.0%.

With CPI-relevance common now in doubt and the likelihood of a recession increasing, observers say the central bank should examine how it monitors core inflation.
Stephen Brown, a veteran Canadian economics expert at Capital Economics, said the Bank’s challenge is treading a very thin line between increasing enough to bring inflation back to target and not tightening enough to trigger a significant recession.
A few analysts said, the Bank of Canada should track how many index constituents are rising faster than the 2% target or just return to the CPIX.
Some claim that because it is simple to understand and resembles how the United States monitors underlying price pressures, the best indicator is inflation minus energy and food.
As per the statement by Derek Holt, director of capital market economics at Scotiabank, the BoC has to address how it has overcomplicated core inflation and the methods it uses.