By Janice Tibbetts
MONTREAL Feb 7 The Bank of Canada signaled a willingness on Friday to ignore the role intense retail competition plays in disinflation, saying that for monetary policy purposes, this is "good disinflation" and likely transitory.
The message could calm any market speculation that the bank wants to cut rates to get inflation back up to its 2 percent target after it has held below that level for the past 20 months.
Tiff Macklem said in his final scheduled public speech as the central bank's senior deputy governor that the bank believes chronically weak inflation reflects both a more competitive Canadian retail scene and slack in the economy, with only the latter considered "bad" and worthy of a central bank rate cut.
"And as we observe disinflation across a number of advanced economies, the message from theory is that monetary policy should work to counter 'bad' disinflation stemming from weak demand, but look through 'good' disinflation from increased competition and improved productivity," he said.
CIBC World Markets said in a note that the speech throws "a few droplets of cold water on hopes for a rate cut."
The bank is just as concerned about below-target inflation as it about high inflation because normally it indicates weakness in the economy.
But Macklem said it was good news that consumer prices had been driven down by the expansion of Walmart discount stores in Canada and the recent arrival of Target and other American retailers.
The bank estimates lower retail prices will subtract about 0.3 percentage point from the core inflation rate in 2014 and that the impact will dissipate after about another year.
It was not clear whether the bank believes the retail environment has had a bigger impact on disinflation than the economic slack, and Macklem stressed that the bank's diagnosis is very uncertain.
The annual inflation rate climbed to 1.2 percent in December from 0.9 percent in November.
Macklem stressed the "flexible" nature of the inflation target, meaning the bank may tolerate inflation straying from the target for longer because it does not want to exacerbate the problem of record-high household debt, which has been fueled by the long period of low lending rates.
The bank has held its main interest rate at 1.0 percent since September 2010 and in October of last year Bank of Canada Governor Stephen Poloz dropped a bias towards a rate hike. He has since said the next move in rates could be up or down.
The Canadian dollar has fallen by about 7 percent against the greenback since that policy shift, but Macklem sought to dispel a perception in the market that the bank was trying to talk down the currency.
"In light of the recent depreciation of the Canadian dollar, it bears stressing that the bank does not have a target for the exchange rate - it has an inflation target," he said. "The exchange rate is determined in markets, and we neither promote any specific value for the Canadian dollar, nor thwart its movements."