Bank of Canada's Poloz: 'We Know How Inflation Works' -- 2nd Update

By Paul Vieira Features Dow Jones Newswires

Growing worries in economic circles about the disconnect between growth and inflation in the developed world have been "greatly exaggerated," Bank of Canada Governor Stephen Poloz said Tuesday.

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In a number of advanced economies, inflation has run short of expectations despite a solid pickup in growth, leading some policy makers and economists to worry about the ability of central banks to manage inflation and inflation expectations.

But Mr. Poloz's speech at a luncheon in Montreal dismissed concerns that the link between economic growth and inflation has been altered.

"The popular perception that inflation has become inexplicable has been greatly exaggerated," he said. "We know how inflation works. The laws of supply and demand have not been repealed."

Many market observers have floated explanations for the perceived disconnect, ranging from growth that isn't as strong as the statistics suggest, to increasingly globalized companies that can outsource production to low-cost jurisdictions and then sell their wares at relatively lower prices.

In his remarks, Mr. Poloz said there may be "some drag" related to globalization and digitization, but said the bulk of the slowdown in Canadian inflation is attributed to below-average food inflation and the province of Ontario's decision to lower electricity bills for households.

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"The bottom line is that the fundamental drivers of inflation, along with some special factors we can identify, can explain the recent behavior of inflation reasonably well," Mr. Poloz said.

Canada's total inflation slowed over the first half of 2017 after reaching a peak of 2.1% in January even while spare production and labor capacity was shrinking rapidly and the country was posting the fastest pace of growth among Group of Seven economies. In recent months, price pressures have firmed, with annual inflation accelerating in September to 1.6%.

He told reporters at the press conference he believes inflation expectations remain well-anchored at 2%. Under the Bank of Canada's inflation-targeting regime, which Mr. Poloz helped design in the late 1980s, the central bank aims to set rates to achieve and maintain the midpoint of a 1% to 3% inflation range.

"Frankly the shortfall from target has been pretty modest, and is well within the band," he said. The central bank expects annual inflation in Canada to reach the 2% target in the second half of 2018, or slightly later than originally anticipated.

Inflation-targeting central banks tend to lower interest rates to help prices adjust whenever demand falters. If there is risk that excessive spending pushes inflation over the target, central banks tend to raise rates to cool growth.

A pickup in inflation can have positive effects on an economy. It might prompt consumers to buy goods and services before prices head even higher. Further, it provides flexibility to firms to offer wage increases to employees, thereby giving consumers more income to spend.

Mr. Poloz also used the speech and a press conference afterward to reinforce the cautious tone the Bank of Canada struck in its most recent policy decision, in which it kept its policy rate unchanged at 1% after increases in July and September.

Mr. Poloz said Tuesday the bank wanted to gauge how Canada's highly indebted households responded to the two previous rate rises, and whether remaining slack in the labor market -- which was weighing on wage growth -- would shrink.

The governor told reporters he was encouraged with labor data last week that indicated the economy added a net 35,300 jobs in October, all of them full-time. The data also suggested average hourly wages rose 2.4% from a year ago, or their fastest pace in roughly 18 months.

Still, "we will need more data points to be assured" that the momentum in wages can be sustained, he told reporters at a press conference.

Write to Paul Vieira at paul.vieira@wsj.com

(END) Dow Jones Newswires

November 07, 2017 17:34 ET (22:34 GMT)