Strategists say the BoC's preferred inflation metrics 'have become biased'

The Bank of Canada's assessment of core inflation metrics is facing scrutiny from two strategists who argue that there are significant biases at play.

In a recent report, Royce Mendes, Desjardins' head of macro strategy, and Tiago Figueiredo, a macro strategist, pointed out a shift in the Bank of Canada's preferred inflation indicators in recent years. They noted that during the pandemic, CPI‑common was sidelined, and policymakers leaned heavily on CPI‑median and CPI‑trim for decision-making.

However, Mendes and Figueiredo suggest that these measures have become skewed, likely resulting in an overestimation of the true underlying inflation rate. They argue that after adjusting for these biases, core inflation appears to be on a downward trajectory, now sitting below three percent, contrary to the Bank of Canada's portrayal.

Unlike headline inflation, which considers all price changes, CPI trim and CPI median aim to filter out extreme outliers, focusing on overall price increases encountered by Canadian consumers.

The strategists caution that relying on "limited influence estimators," such as CPI median and CPI trim, may not be ideal for real-time policy decisions. While these measures aim to smooth out erratic price fluctuations, they might overlook crucial signals about economic health and underlying inflation, especially during periods of skewed price changes in the economy.

They emphasize that Canada's current economic landscape exhibits a heavy skew in price changes, indicating a bias in CPI-median and CPI-trim figures. To rectify this bias, the strategists propose adjustments to provide a more accurate representation of core inflation.

Following the adjustment, they find that bias-corrected CPI-median and CPI-trim figures are notably lower than the unadjusted numbers used by the Bank of Canada for policy decisions.

The strategists assert that these bias-adjusted figures present a different narrative regarding the trajectory of core inflation. They suggest that the recent inflation reading, which fell significantly below forecasts, offers the Bank of Canada an opportunity to adopt a more dovish stance in April, even if policymakers are hesitant to acknowledge that their preferred inflation measures may have led them astray.

In conclusion, the critique from Mendes and Figueiredo underscores the importance of re-evaluating inflation metrics used by central banks to ensure accurate policy decisions aligned with economic realities.