Why The Bank Of Canada Isn't Raising Rates Any Time Soon, In One Chart

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Stephen Poloz and his colleagues at the Bank of Canada are probably breathing a little easier after the latest inflation print.

In June, the headline inflation rate accelerated to 2.4 percent, above the midpoint of the Bank's 1 to 3 percent target range.

Just days prior to that print, the Bank affirmed its data-dependent neutral stance, saying that a rate cut was as likely as a rate hike.

This morning, Statistics Canada reported that headline inflation eased in July, rising 2.1 percent year-over-year.

'[I]nflation's calmer tone after the first-half run-up will come as a significant relief for policymakers,' asserted Bank of Montreal chief economist Douglas Porter.

The Bank had recently shifted its focus from headline inflation to the output gap, which shows a significant amount of slack still remains in the Canadian economy.

Well before Janet Yellen suggested that the recent uptick in inflation south of the border was driven by noise in the data - a call that proved to be correct, as Business Insider's Joe Weisenthal points out - Stephen Poloz was telling market participants that the run-up in inflation in Canada was fuelled by temporary factors.

Just as was the case with his counterpart in the United States, Poloz has been vindicated by this morning's inflation print: the largest contributor to the slow-down in inflation was a drop-off in the transportation segment, as gasoline prices fell about 2 percent from June.

Gluskin Sheff chief economist and strategist David Rosenberg sang the governor's praises in his daily note, which included as section titled 'Poloz was Prescient!'

'The softer inflation reading supports the Bank of Canada's view that the sharp acceleration in inflation seen over the first half of the year in part was due to transitory factors that will subside going forward,' he wrote. 'Moreover, the moderation in inflation eases pressure on the central bank to take a more hawkish stance towards monetary policy in an effort to combat inflationary pressures.'

In the past, we've suggested that the parabolic rise in the price of bacon served as the perfect example for why the surge in inflation didn't warrant a response from monetary policymakers. The price of the delicious, artery-clogging supplement to scrambled eggs was spiking because of supply issues - namely, the PEDv pig virus that results in the deaths of millions of pigs - rather than a pick-up in disposable income that caused consumers to throw more dollars at the same amount of supply, putting upward pressure on prices.

(Baconflation, by the way, is running above 27 percent on a year-over-year basis as of July, though the rate of monthly increases slowed substantially in this reading.)

However, there's a more conventional - and important - metric one can point to in order to illustrate the lack of domestically-driven inflationary pressures. In a note published on Thursday, TD economists Randall Bartlett and Derek Burleton pointed out nominal wage growth has actually decelerated recently, and the rise in inflation has pushed real wage growth into negative territory:

It's tough to make the argument that there are domestically-driven inflationary pressures when nominal wage growth is declining and Canadians' purchasing power is decreasing. The situation is similar to 2011, the previous period in which real wage growth was negative, in that higher energy prices played the key role in propelling the headline inflation rate higher.

In light of this 'noisy' inflation, monetary policymakers are currently focused on excess supply in the labour market and the lingering output gap. To this end, the Bank of Canada's July Monetary Policy Report stated that 'Continuing labour market slack is also reflected in subdued increases in wages.'

'Developments in the labour market, and wage growth in particular, are concerning enough that Bank of Canada Governor Stephen Poloz placed greater than usual emphasis on them in the Bank's July 2014 Monetary Policy Report,' wrote Bartlett and Burleton.

As such, when it comes to how wage growth affects monetary policymakers' decision-making process, Poloz is surely closer to Janet Yellen - who indicated the degree of labour market slack implies that 'there is scope for nominal wages to accelerate from their recent pace without creating meaningful inflationary pressure' - than Mark Carney, who has said the Bank of England is open to hiking rates before real wages are actually trending higher.

Lucas Kawa is the Editor of Business in Canada. He graduated from St. John's University with a B.S. in Economics. Previously, Lucas wrote for Business Insider's MoneyGame and Clusterstock verticals. Follow him on Twitter.

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