Bank of Canada governor says fundamental factors continue to drive inflation

Poloz defended the bank's decision to raise rates despite inflation remaining below the 2 percent midpoint of its target range, and later told reporters the bank was open to allowing inflation to overshoot the target after a period of undershooting it - at least in the short term.

In a luncheon speech to CFA Montreal and the Montreal Council on Foreign Relations, Poloz said the fundamental drivers of supply and demand, as well as short-term factors, can explain the movement in prices and that the popular perception that inflation has become inexplicable is exaggerated.

Bank of Canada Gov. Stephen Poloz said consumer price inflation targeting was still a useful mechanism for central banks, even though inflation has been notoriously low in developed economies of late.

Mr. Poloz also said several temporary factors are keeping prices low, including low food inflation caused by intense competition and healthy crops as well as Ontario's lowering of electricity rates. "Well, it would be curious indeed for the central bank to pump up inflation in other parts of the economy to somehow offset "good disinflation" in other parts". He added there also may be "some drag" related to globalization and digitization.

"Governor Poloz walked a tricky line between defending the rate hikes he's already delivered as reasonable given the inflation outlook, while still acknowledging enough of a grey area in the forecast to be cautious about delivering the next move", Canadian Imperial Bank of Commerce chief economist Avery Shenfeld said in a research note. "We know how inflation works". The Bank of Canada has hiked its overnight rate twice this year - to one per cent - reversing two quarter percentage-point cuts it made in 2015 as the oil price shock rattled the Canadian economy. That regime was renewed in 2016, with the central bank introducing three new measures of core inflation to get a better grasp of underlying price pressures. Poloz last spoke in testimony to House of Commons and Senate committees in the days following the bank's Monetary Policy Report and policy meeting on October 25, when the bank held interest rates steady.

Poloz warned the closer Canada gets to full output and employment the greater the risk inflation pressures will appear, and repeated his message that less stimulus will be required over time. The central bank expects annual inflation in Canada to reach the 2% target in the second half of 2018, or later than originally anticipated.

At a press conference after the speech, Poloz rejected the idea he would let the economy run hot and inflation to push past 2 percent.

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