Bank of Canada governor Stephen Poloz on Friday fulfilled a ceremonial role by unveiling a glamorous new $10 bill to celebrate the country's sesquicentennial. 

This week, Poloz will discharge an even more fundamental duty, announcing the policy that makes sure the fancy 10, and the rest of Canada's money, retains its value.

With inflation at two per cent, with the economy continuing to crank out jobs, and with continuing signs of an overheated housing market in many Canadian cities, the governor will face growing pressure to raise interest rates.

So far Poloz has shown no inclination to follow U.S. Fed chair Janet Yellen in her move to put rates higher. In fact the last time he talked about changing rates, he was discussing a cut.

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U.S. Federal Reserve chair Janet Yellen, here with Treasury Secretary Steve Mnuchin, hiked rates and promises more while Poloz has holds steady. (Kai Pfaffenbach/Reuters)

"Especially with inflation being below target for a prolonged period, yes, a rate cut remains on the table and it would remain on the table as long as those downside risks are still present," said Poloz in January

Even though a widening spread between U.S. and Canadian rates should also widen the gap between the two currencies, the metrics the Bank of Canada uses to guide its policy mean the governor may be in no rush to change Canadian rates.

Despite a recovery in trade and a job market that keeps growing, Poloz repeatedly offers a gloomy outlook on Canada's economic future, worrying about "serial disappointment" every tme the economy starts to show signs of health.

Talking the dollar down

That has led some to say the governor is talking the dollar down — using words rather than interest rates to make Canadian exports cheaper on world markets. Poloz has denied doing that.

His gloom seemed justified after the latest trade numbers showed Canada moving into deficit after three months of surpluses.

But on Friday, an unexpected boom in Canadian job creation told a different story.

"The Canadian economy is showing lots of momentum and these latest employment numbers are part of that picture," said CIBC chief economist Avery Shenfeld.

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Vehicles ready for shipment from from General Motors CAMI car assembly plant in Ingersoll, Ont., are contributing to Canada's warming economy. (Geoff Robins/Reuters)

Shenfeld says we are close to the point where employers will have to start bidding up the price of labour, one of the triggers for price inflation.

"We're already at the kind of unemployment rate that would typically require employers to pay up for additional workers by raising wages, and that's what they're reporting in this survey that comes out separately of employers," said Shenfeld.

As to rising house prices, BMO economist Robert Kavcic has scoffed at Poloz's assertion that low interest rates are not responsible. Kavcic says the Bank of Canada's statements that rates will stay low are just encouraging home buyers to bid up prices.

Mathematical magic

Headline inflation, the increase in the actual cost of the things Canadians buy, has reached two per cent. Rising rents in some places and rising prices for essential products leave many consumers feeling their wages aren't keeping up.

But a look at the statistics the Bank of Canada uses to make its rate decision justifies Poloz's intransigence.

The price of the basket of goods that the bank uses to determine the consumer price index is rising at two per cent a year. But Poloz and his advisers use different measures of the consumer price index to judge whether the economy is overheating.

Until the end of last year, the bank used to use a measure of core inflation which was regular inflation with a few notoriously volatile items in the standard basket of goods, including energy, stripped out.

As of October 2016, it has been replaced with three core measures:

  • CPI-trim, as it's called, simply chops off what are sometimes called the long tails of price data, using the 60 per cent of CPI components that are the least unusual that month. That means things such as a sudden frost in the orange groves — a poor indicator of overcapacity in the Canadian economy — will not influence the Bank of Canada's decision.
     
  • CPI-median lines up the sectors in order of their one-month volatility and uses the middle one.
     
  • CPI-common is a mathematical marvel created by the Bank of Canada, churned out by Statistics Canada computers, that uses historical data and a 55-dimensional regression to tease out a common inflation factor that fits them all.

All three leave out tax increases because higher taxes don't indicate economic overcapacity pressure.

But most importantly, all three core measures of CPI show the economy is nowhere near the verge of overheating.

Besides, two per cent is just the midpoint in the target range. Poloz has the latitude to let inflation go as high as three.

Of course, that does not let him off the hook entirely. Research indicates small rises in rates can take months or years before they work through the economy and begin to restrain prices. 

While almost no one expects the governor to start raising rates this week or anytime soon, a first step to watch for is a greater emphasis that such rate hikes have now become a serious possibility.

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